Aspiring to spark an informed debate about investment markets, value, and absolute returns.

“In journalism and blogging, a listicle is a short-form of writing that uses a list as its thematic structure, but is fleshed out with sufficient copy to be published as an article. A typical listicle will prominently feature a cardinal number in its title, such as "10 Ways to Warm Up Your Bedroom in Winter", "The 5 Most Badass Presidents of All-Time", or "25 Hairstyles of the Last Hundred Years", with subsequent subheadings within the text itself reflecting this schema. The word is a portmanteau derived from list and article. It has also been suggested that the word evokes "popsicle", emphasising the fun but "not too nutritious" nature of the listicle.”

Given the number of outrageous, unlimited, uncontrolled and untested economic experiments being conducted largely in his name by desperate central bankers, it may seem bizarre to be comparing the British ‘stimulus’ economist John Maynard Keynes with the US ‘value’ investor Benjamin Graham. (That may have something to do with the fact that Keynes is being given a bum rap. The author of ‘The General Theory of Employment, Interest and Money’ was breathlessly lauded by Time magazine in 1999: “His radical idea that government should spend money they don’t have may have saved capitalism”. What the QE lobby fail to appreciate, or wilfully ignore, is that Keynes also advocated having governments run budget surpluses during periods of economic growth. But when you’re advising other people how to waste other people’s money, why expend any intellectual effort on the task ?) In any event, here is a listicle challenge for readers. Which of the following quotations were said by Keynes, and which by the father of ‘value’ investing, Ben Graham ?

On market volatility

“One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact or lose one’s sense of proportion.”

“Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market.”

“The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizeable declines nor become excited by sizeable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored.”

“It is largely the fluctuations which throw up the bargains and the uncertainty due to the fluctuations which prevents other people from taking advantage of them.”

“The wider the fluctuations of the market, and the longer they persist in one direction, the more difficult it is to preserve the investment viewpoint in dealing with common stocks. The attention is bound to be diverted from the investment question, which price is attractive or unattractive in relation to value, to the speculative question, whether the market is near its low or its high point.”

On the significance, and psychological challenge, of being a contrarian investor

“The central principle of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merit, the investment is invariably too dear and therefore unattractive.”

“The fact that other people agree or disagree with you makes you neither right nor wrong. You will be right if your facts and reasoning are correct.”

“It is the one sphere of life and activity where victory, security and success are always to the minority and never to the majority. When you find anyone agreeing with you, change your mind.”

On the limitations of professional fund managers

“An investment operation is one which, upon thorough analysis, promises safety of principle and a satisfactory return. Operations not meeting these requirements are speculative.”

“It is a leading fault of all institutional investors that their portfolio gradually tends to contain a long list of forgotten holdings originally purchased for reasons that no longer exist.”

[In response to the following statement: “Relative performance is all that matters to me. If the market collapses and my funds collapse less that’s okay with me. I’ve done my job.”]

“That concerns me, doesn’t it concern you ? ..I was shocked by what I heard at this meeting. I could not comprehend how the management of money by institutions had degenerated from the standpoint of sound investment to this rat race of trying to get the highest possible return in the shortest period of time. Those men gave me the impression of being prisoners to their own operations rather than controlling them.. They are promising performance on the upside and the downside that is not practical to achieve.”

On the importance of taking a long term perspective

“Human nature desires quick results, there is a peculiar zest in making money quickly, and remoter gains are discounted by the average man at a very high rate.”

“Undervaluations caused by neglect or prejudice may persist for an inconveniently long time, and the same applies to inflated prices caused by overenthusiasm or artificial stimulus.”

“An investor is aiming, or should be aiming, primarily at long-period returns, and should be solely judged by these.”

On price and value

“It is unsound to think always of investment character as inhering in an issue per se. The price is frequently an essential element, so that a stock may have investment merit at one price level but not at another.”

“I believe now that successful investment depends on.. a careful selection of a few investments having regard to their cheapness in relation to their probably actual and potential intrinsic value over a period of years ahead.. a steadfast holding of these in fairly large units through thick and thin, perhaps for several years.”

“All my experience goes to show that most investment advisers take their opinions and measures of stock values from stock prices. In the stock market, value standards don’t determine prices; prices determine value standards.”

“Prices bear very little relationship to ultimate values.”

On a ‘margin of safety’

“I am still convinced that one is doing a fundamentally sound thing, that is to say, backing intrinsic values, enormously in excess of the market price, which at some utterly unpredictable date will in due course bring the ship home.”

“Another useful approach.. is from the standpoint of taking an interest in a private business. The typical common-stock investor was a businessman, and it seemed sensible to him to value any corporate enterprise in much the same manner as he would his own business.”

For a bonus point: On why ‘beta’ (volatility) and risk are not the same thing

“Beta is a more or less useful measure of past price fluctuations of common stocks. What bothers me is that authorities now equate the beta idea with the concept of risk. Price variability, yes; risk no. Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic changes or deterioration in management.”

So how did you fare ?

Answers:

Keynes.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Graham.

Keynes.

Keynes.

Graham.

Graham.

Intriguing, n’est-ce pas ? There is clearly more common ground between the Cambridge University ‘father of modern economics’ and the Columbia Business School ‘father of ‘value investing’ than one might have previously thought.

“March 17 – Bloomberg (Kelly Bit): “Ray Dalio, founder of the world’s largest hedge fund firm, Bridgewater Associates, told investors there’s a risk that the Federal Reserve could create a market rout similar to that of 1937 if it raises interest rates too fast… ‘We don’t know -- nor does the Fed know -- exactly how much tightening will knock over the apple cart,’ Dalio and Dinner wrote. ‘We think it would be best for the Fed to err on the side of being later and more delicate than normal.’”

“Sometimes I feel as if I’m living on a different planet. As much as I respect the intelligence and market acumen of Jeffrey Gundlach and Ray Dalio, I take strong exception with some of their comments on Fed monetary policy. Dangerously flawed policymaking is only perpetuated by further delays in rate normalization. I also reject the comparison to 1937. Even at its 1937 highs, the Dow remained about half the 1929 peak. Unemployment sat above 14%. Today’s parallels are much closer to 1929. Regrettably, the Fed drew the wrong lessons from the “tech” and mortgage finance Bubble episodes. Now, everyone wants this party to last forever.”

Millions of investors across western economies have been peering nervously into the sky for clues about future market direction after unprecedented goings-on in the heavens. Analyst Marti Venal of CravenFokker Investments commented that a vast swathe of the earth’s surface being suddenly plunged into darkness was probably not a terrific omen for the stock market, although he was willing to make an exception for every IPO that his employer had underwritten. Senior astrologist Jed Meggar-Boom of Pimhole Securities disagreed, pointing to his firm’s proprietary research into clay models of sheep livers, and advocated taking aggressive leveraged positions in four year Danish mortgage securities. The executive management team of the ..AndIt’sGone Hedge Fund Consortium were taking no chances, having replaced their Chief Executive Officer for the duration of the solar eclipse with a substitute, atop a bronze throne, made up of twigs; former CEO Greg Ponzee was reportedly hiding under the coffee machine with one of his secretaries. Not all capital markets participants elected to flee the intriguing and possibly auspicious solar disturbance; market-makers at DweezilZap Securities, directly in the path of the moon’s umbra, as at press time had ritually sacrificed all the firm’s interns and were running around the dealing room smeared in camel dung. (Commentators pointed out that this was actually a regular occurrence, especially after a heavy Thursday night.) Typically, the closer observers were to the City of London, the more likely they were to experience utter diminution of their critical faculties. Those further away had an uninterrupted and entirely clear view of the spectacle. And not all sky-watchers enjoyed a cosmic display of equal duration. Two days after the event had concluded, and as Phoebus’ fiery chariot was once again wheeling through the heavens unassailed, Federal Reserve chairperson Janet Yellen admitted to being still completely in the dark.

We jest, of course. Or do we ? In a world in which hundreds of analysts spend thousands of man hours debating the presence or absence of the adjective ‘patient’ in the latest FOMC minutes, it’s sometimes difficult to distinguish between satire and reality. Keynes expressed the problem well:

“..we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.”

The danger lies not just in mismanagement of a machine. The danger lies in the over-simplicity of the metaphor itself. What if the economy is not some machine offering essentially binary outcomes, what if the economy is in fact (as it surely is) a complex living, breathing thing reflecting the countless interactions between millions of individual economic actors, who are ultimately less rational than the economics ‘profession’ would have us believe ?

In such an economy, people err. The authoritarian instinct starts to reveal its limitations, rather publicly. It is facile to believe that a self-appointed committee of twelve people tasked primarily with protecting the interests of the banking system that ultimately employs them can assert the ‘correct’ price of money for the 320 million people in that economy and indirectly for the 6.7 billion who live outside it. It would be ludicrous to believe anything else. But that is the system we currently have.

It is, as Doug Noland points out, nearly two years since Ben Bernanke talked of winding down QE and starting to normalise monetary policy.

“The Fed’s current focus should not be the dollar, CPI or even the employment rate. The primary consideration after six years of zero rates and $3.6 trillion of monetisation should be Financial Stability. The Fed needed to be prepared to counter securities market and speculative excesses. They have failed to do the obvious, and Wednesday’s [FOMC] meeting confirms they will remain firmly in Bubble accommodation mode.

“I have argued for a number of years now that it was imperative for the Fed to begin extricating itself from market intervention and manipulation. It was never going to go smoothly, but when it comes to dealing with market distortions and Bubbles, the earlier the better. The scope of the Bubble has now grown to unprecedented dimensions – throughout virtually all securities and asset markets – and it's global: stocks – small caps, mid-caps, large-caps – risky and “defensive” – growth and income; bonds – sovereign, corporate, “developed” and “developing”; and all varieties of derivatives. Anything providing a yield.

“The fundamental issue is a desperate need for the Fed to commence a process of normalising the pricing of market risk. Savings needs to generate a positive real return. The enormous ongoing flow of (unsuspecting) savings into grossly inflated risk markets only exacerbates systemic risk. The Bubbling corporate debt market needs to be tested – and some market discipline reinstated. The ETF and “bond” fund complexes, recipients of Trillions of flows, need to be tested – and market discipline allowed to run its course. The self-reinforcing stock buybacks, M&A and other “financial engineering” need to be tested by a period of tighter finance and associated risk aversion. Will they stand up ?”

The financial world has bifurcated sharply into just two camps: savers, and speculators. All the forces of the world’s central banks have been devoted to shafting the former and encouraging the latter. The process ends badly. When Danish borrowers are paid to borrow by their banks and Danish savers are penalised for keeping money in the bank, something has gone gravely wrong with the financial system. Something is rotten, and not just in Denmark.

Market historian Russell Napier develops this theme:

“..in the Eurozone the failure of monetary policy is more palpable. We have inflation and interest rates already in the world of ‘minus zero’. And it is not just the ECB’s deposit rate which has entered minus zero territory. The yield on seven-year German Bunds has fallen from 3.2% in 2011 to -0.03% today. At the short end of the curve the yield on three-month government paper has declined to -0.91% in Denmark, -0.80% in Switzerland and -0.25% in Sweden. There are now trillions of Euros of financial assets which yield less than banknotes.

“The Solid Ground has opined before on how such a development marks a distinct limit to monetary policy. The banknote is now becoming an increasingly attractive investment and any move to banknotes away from deposits creates a run on the banking system. This has not happened. Yet. However, with the vast bulk of ECB purchases of assets still to come, the move to negative nominal interest rates has just begun. At some stage a shift to banknotes will begin and the limits to monetary policy will become much clearer.

The spluttering torch of reflation will have to be passed to governments, and extreme government measures, such as outlawing cash holdings, are already under discussion. Investors should look to the imposition of a Tobin tax on capital inflows in Sweden, Switzerland or Denmark as a key indicator that central bank action will have to be bolstered by direct government intervention in markets.”

In all the annals of investing, few seemingly innocuous phrases incorporate as much by way of grave implication as those four words, “a shift to banknotes”. 2008 was bad. With central bank policy now at the outer reaches of the possible and even of the theoretical, the outlook is certainly uncertain. Not wishing to participate in the terminal stages of a momentum-driven bubble is not bearish so much as simply sane.

Rosser Reeves was one of the most celebrated American advertising executives from the 50s onwards – he helped define the era of ‘Mad Men’. There’s a story about him, now many times retold; the version that Daniel H. Pink tells (in his book ‘To sell is human’) goes as follows. Reeves and a colleague were having lunch one day in Central Park. On their way back to Madison Avenue, they came across a beggar. The man was holding a cup for donations and a handwritten cardboard sign, that read:

I AM BLIND.

Sadly, the man’s cup was almost empty. His plight, for some reason, was not moving people to donate. Reeves immediately told his colleague that he could see what the problem was; he bet his colleague that he could dramatically increase the money in the beggar’s cup, simply by adding four words to his sign. His colleague, intrigued, took him up on the bet. Reeves then introduced himself to the man, explained that he was in advertising, and offered to change his sign slightly to increase people’s willingness to give. The man agreed. Reeves took out a pen, added his four words, and with his colleague stepped back to watch. Almost immediately, passers-by started to drop coins into the blind man’s cup. Others came by, began talking to the man, and took dollar bills from out of their wallets. Pretty soon, the man’s cup was overflowing with cash. What four words did Rosser Reeves add to the sign ?

IT IS SPRINGTIME AND

The new sign, that captured the sympathy and triggered the generosity of passers-by, read:

IT IS SPRINGTIME AND I AM BLIND.

By nudging people to put themselves in the position of the beggar, Reeves was exploiting something psychologists call “the contrast principle”. He was arguably “guilting” people into giving. But most observers would conclude that, assuming this story isn’t apocryphal, the end justified the means.

Asset gathering businesses don’t need to be as subtle when it comes to their own marketing. Given that the business of investing implicitly assumes the generation of positive returns, fund marketers can simply appeal to their customers’ self-interest. That said, as the author Guy Fraser-Sampson points out, people’s investment decisions are driven by emotion, not numbers, so expecting logical decision-making on the part of prospective customers may be a step too far. The rational investor is a myth.

Ben Graham wrote in 1934 about the bull market of the Roaring Twenties that met its fateful toreador in 1929:

“The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis. If a…stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, which was the pre-boom standard, the conclusion to be drawn was not that the stock was now too high but merely that the standard of value had been raised. Instead of judging the market price by established standards of value, the new era based its standards of value upon the market price. Hence all upper limits disappeared, not only upon the price at which a stock could sell but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase at $100 a share of common stocks earning $2.50 a share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price.”

Walter Bagehot wrote that people are most credulous when they are most happy. Given that many stock (and bond) markets are now trading at record highs, we must assume that there are plenty of happy people out there. But as Lord Overstone also counselled:

“No warning can save people determined to grow suddenly rich.”

It is in the nature of people to extrapolate from the recent past. In the recent past, stocks have been a one-way bet. Such is life under a regime of limitless liquidity and zero percent interest rates (or even lower). As for bonds, there is probably not a trader still toiling in a dealing room who has experienced anything other than declining rates during the entire duration of their career. This is not an environment conducive to the future stability of asset prices.

Jason Zweig has written nicely of the stark differences between asset gathering firms and asset management firms. We highlighted them in January. We highlight them again today. Among the differences:

“The marketing firm has a mad scientists’ lab to “incubate” new funds and kill them if they don’t work. The investment firm does not.

The marketing firm charges a flat management fee, no matter how large its funds grow, and it keeps its expenses unacceptably high. The investment firm does not.

The marketing firm refuses to close its funds to new investors no matter how large and unwieldy they get. The investment firm does not.

The marketing firm hypes the track records of its tiniest funds, even though it knows their returns will shrink as the funds grow. The investment firm does not.

The marketing firm creates new funds because they will sell, rather than because they are good investments. The investment firm does not.

The marketing firm promotes its bond funds on their yield, it flashes “NUMBER ONE” for some time period in all its stock fund ads, and it uses mountain charts as steep as the Alps in all its promotional material. The investment firm does none of those things.

The marketing firm pays its portfolio managers on the basis not just of their investment performance but also the assets and cash flow of the funds. The investment firm does not.

The marketing firm is eager for its existing customers to pay any price, and bear any burden, so that an infinite number of new customers can be rounded up through the so-called mutual fund supermarkets. The investment firm sets limits.

The marketing firm does little or nothing to warn its clients that markets do not always go up, that past performance is almost meaningless, and that the markets are riskiest precisely when they seem to be the safest. The investment firm tells its customers these things over and over and over again.

The marketing firm simply wants to git while the gittin’ is good. The investment firm asks, “What would happen to every aspect of our operations if the markets fell by 67% tomorrow, and what would we do about it? What plans do we need in place to survive it?”

None of which is to denigrate either stock or bond markets in isolation – just expensive stock and bond markets. How do you tell when a stock market is expensive ? Well, John Hussman wrote at the beginning of March that

“Last week, the cyclically-adjusted P/E of the S&P 500 Index surpassed 27, versus a historical norm of just 15 prior to the late-1990’s market bubble. The S&P 500 price/revenue ratio surpassed 1.8, versus a pre-bubble norm of just 0.8. On a wide range of historically reliable measures (having a nearly 90% correlation with actual subsequent S&P 500 total returns), we estimate current valuations to be fully 118% above levels associated with historically normal subsequent returns in stocks. Advisory bullishness (Investors Intelligence) shot to 59.5%, compared with only 14.1% bears – one of the most lopsided sentiment extremes on record. The S&P 500 registered a record high after an advancing half-cycle since 2009 that is historically long-in-the-tooth and already exceeds the valuation peaks set at every cyclical extreme in history but 2000 on the S&P 500 (across all stocks, current median price/earnings, price/revenue and enterprise value/EBITDA multiples already exceed the 2000 extreme). Equally important, our measures of market internals and credit spreads, despite moderate improvement in recent weeks, continue to suggest a shift toward risk-aversion among investors. An environment of compressed risk premiums coupled with increasing risk-aversion is without question the most hostile set of features one can identify in the historical record.”

That sounds a little like the broad US market might be expensive. What about bonds ? Investors have historically bought bonds for two main reasons: capital preservation, and yield. At current prices and interest rates, many sovereign bond markets now offer neither. All the way out to seven years, German government bonds now offer negative yields to maturity. Investors who buy those bonds today are guaranteed to lose money if they hold to term. They will be paying a premium to par to earn a derisory annual coupon and they will only be paid par on redemption. That sounds a little like German government bonds, for example, might be expensive.

Only a cretin would be buying supposedly safe bonds (which clearly aren’t) with negative yields. Who is likely to be buying these bonds ? To paraphrase Die Hard villain Hans Gruber:

“You asked for miracles, Theo; I give you the ECB.”

Dr Robert Gay of Fenwick Advisers, formerly a Senior Economist with the Board of Governors of the Fed during the chairmanship of Paul Volcker, suggests that there are three problems with Mario Draghi’s just-begun Quantitative Easing Programme at the ECB:

3) It’s entirely ineffectual – it throws sand in the wheels of bank deleveraging by punitively paying negative interest on excess reserves; it hurts savers with negative deposit rates; there’s no direct transmission to the real economy; and it’s likely to postpone deleveraging by the large debtor countries of the euro zone (i.e. all of them).

Other than that, it’s an entirely sound plan with every chance of success.

Conclusions, given the above ?

Avoid the major indices, both for stocks and bonds. Do not pursue cheap, broad market exposure – specialise.

Danish sex therapist Eva Christiansen stands a good chance of becoming the definitive example for future historians of our current interest rate insanity. The New York Times reports that the 36-year-old businesswoman has just been approved for a small business loan at a rate of minus 0.0172 percent. The bank is actually paying her interest on the loan – albeit just over $1 a month. Representing the flip side of this nonsense is the 27-year-old Danish student Ida Mottelson. Her bank just wrote to her advising that it would be charging her 50 basis points (0.5%) to hold her money on deposit. What’s wrong with this picture ?

The French economist Frederic Bastiat created what may be the most powerful – and perhaps most overlooked – metaphor in finance, in his 1850 piece ‘That which is seen, and that which is not seen’. It goes as follows:

A young boy happens to break a shopkeeper’s window. Pretty soon a crowd gathers, which quickly becomes philosophical:

“It is an ill wind,” says the crowd,

“that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken ?”

Bastiat nicely catches the intellectual mood of the mob. Let’s say it costs six francs to repair the window. That is six francs given to the glazier, who can spend it as he will. The six francs will circulate in the wider economy. Perhaps we should break more windows and watch the economic stimulus take hold. The six francs given to the glazier are what is seen.

What is not seen is what the shopkeeper might have done with those six francs had he not been obliged to pay them to the glazier. He would, perhaps, have replaced some old shoes, or bought a book for his library. If he were markedly stupid and easily led, he could perhaps have bought ‘End this depression now !’ by Paul Krugman, or ‘Capital in the twenty-first century’ by Thomas Piketty. But what’s important is that he doesn’t have those six francs any more. Whatever he might have done with the money is now not seen:

“To break, to spoil, to waste, is not to encourage national labour; or, more briefly,

“Destruction is not profit.”

The Austrian economic school has a term for those things that are undertaken foolishly in the economy, perhaps because the pricing mechanism has become hopelessly distorted. It terms them ‘malinvestments’. Do we think malinvestments are more or less likely to happen when people are actually paid to borrow money ? Do we think malinvestments are more or less likely to happen when people are actively penalized for saving ? When there is a punitive cost for holding money on deposit at a bank, are malinvestments more or less likely ? What about money hoarding ? Or ultimately, following the introduction of negative interest rates, a run on banks altogether ? Money destruction is not profit either.

One dreads to think what problems are being stored up for the future by the current monetary policy of our central banks. We have made this point before on innumerable occasions. But an argument is not wrong simply for its being frequently repeated. In this week’s Spectator, Ros Altmann draws attention to the damage being wrought on pension funds by Quantitative Easing:

“During last year, company scheme deficits rose by more than £200 billion, as pension assets increased by around 10 percent but liabilities (which increase when bond yields fall) rose by over 25 percent..

“It is not just company pensions that have been hit. Private pension funds have been damaged too. Annuity rates depend on bond yields – and the lower yields fall, the lower retirees’ annuity pensions will be for the rest of their lives..

“..as gilt prices have driven pension deficits up, pension advisers have increasingly recommended that trustees reduce the risks of their pension schemes. The traditional way to do this has been to buy more bonds and sell shares, so trustees have felt forced into buying bonds, whatever their long-term value.”

Buying assets irrespective of their long-term value is in some contexts referred to as ‘greater fool theory’. That would seem to be the case in the euro zone, where Mario Draghi at the ECB is just about to begin a €1.1 trillion Quantitative Easing programme. Banks and other institutions have already driven down the yields of many sovereign bonds into negative territory (according to ABN Amro, more than a quarter of government bonds in the euro zone now have negative yields), in anticipation that some ‘greater fool’ will take them off their hands. Enter Mario Draghi.

Awkwardly, the ECB’s bond buying programme may prove to be the most ill-timed securities purchase programme in history. That was already the case given that interest rates are now at 5,000-year lows. It looks even more like the case given how bond markets behaved on Friday. “Treasuries in biggest rout since 2009 as job gains spur Fed bets,” reported Bloomberg. Last week the long bond, the 30 year US Treasury, saw its yield rise by 25 basis points to 2.84%. Mr Draghi may be bringing a knife to a gunfight.

Meanwhile, investment consultants will continue to give pension funds the benefit of their advice. That advice, both at a macro and a micro level, may be worth less than nothing; an academic paper has just won the 2015 Commonfund prize for concluding

“we find no evidence that [consultants’] recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless.”

So other than being unable to offer any practical advice whatsoever other than to recommend buying government debt at its most expensive levels in world history, perhaps ahead of a grave turning point in the market, and being unable to add any value either in specific fund manager recommendations, pension consultants are clearly well worth the fees they charge to their gullible pension fund clients.

Lest this seem a counsel of despair, for any investor unconstrained by benchmark or regulatory fiat, there is an answer. It lies in the sad passing, just reported, of the late Irving Kahn, at the age of 109. Kahn was a teaching assistant to Benjamin Graham, the dean of value investing and a man whose influence on and development of the principles of successful investing was second to none.

Now, more than ever, is a time to insist that our investments carry a “margin of safety” – the cushion represented by buying assets (today, most likely to be equity assets, and almost certainly not most sovereign bonds) at a meaningful discount to their inherent value. At a time when few financial prices can really be trusted, courtesy of a tidal wave of QE that is lifting most boats, stocks possessing a “margin of safety” ensure that we run the least risk of consciously overpaying for our investments. Irving Kahn long ago “stopped wasting time on what people claimed a stock was worth and started looking at the numbers”.

Value investing – attempting to buy dollar bills for forty or fifty cents – always makes sense, but it makes a whole lot more sense when risk-taking and asset market reflation are off the charts. The alternative, which has become bizarrely popular among those retail investors flocking into index-tracking ETFs, is simply to gain broad market exposure. That is surely a grisly accident waiting to happen. John Hussman points out that

“the present moment likely represents the best opportunity to reduce exposure to stock market risk that investors are likely to encounter in the coming 8 years.. An environment of compressed risk premiums coupled with increasing risk-aversion is without question the most hostile set of features one can identify in the historical record.”

So the choices seem pretty clear. Track absurdly expensive stock markets higher. Buy government bonds at their most expensive levels in history – even as there are early signs that the interest rate cycle may finally be about to turn. Or take shelter in the sort of value stocks that made Irving Kahn, Ben Graham and Warren Buffett mightily successful long-term investors. Doesn’t seem like a particularly difficult choice to us.

“The FTSE 100 has at last topped the record it set at the close of 1999. Should Britons celebrate ? Probably not.”

- John Authers, The Financial Times, ‘FTSE hits record, but hold off the bubbly.”

“To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up in price, we weep. For most people, it’s the same with everything in life they will be buying — except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”

- Warren Buffett, 10th December 2001.

“I’m thinking of making a purchase of Berkshire [Hathaway], but I’m concerned about something happening to you, Mr. Buffett. I cannot afford an event risk.”

- Attendee at a shareholders’ meeting of Berkshire Hathaway.

“Neither can I.”

- Warren Buffett’s response.

“The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.”

- Benjamin Graham.

“Investors’ delight as shares smash record.”

- The Times.

On the fiftieth anniversary of Warren Buffett’s taking control of the Berkshire Hathaway company, his annual letter to shareholders has been keenly anticipated. It does not disappoint. The compounded annualised gain in book value per share for the company from 1965 to 2014 equates to 19.4%. The annualised percentage gain for the S&P 500 over the same period, with dividends reinvested, equates to 9.9%. That differential has delivered astronomical comparative performance. The overall gain for the US market comes to 11,196% over the period. The overall gain for Berkshire Hathaway stock comes to 751,113%. If the efficient market hypothesis were correct, a differential of that magnitude could not possibly exist, in this or any other universe. As Buffett himself has remarked,

“I’d be a bum on the street with a tin cup if the markets were always efficient.”

So it is something of a shame that Buffett has never been awarded a Nobel prize for economics, as opposed to Eugene Fama, the father of the efficient market hypothesis, who has. No doubt Buffett’s net worth of roughly $60 billion takes some of the sting away.

Buffett in this year’s letter takes an explicit swipe at another piece of conventional investment wisdom – the idea that risk is essentially encapsulated in price volatility (step forward, Harry Markowitz, and any number of cheerleaders and ‘consultants’ who claim to be professional investors):

“For the great majority of investors.. who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities [i.e. cash and bonds]. If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement.”

In October 2009, Buffett’s business partner and Berkshire Hathaway Vice-Chairman Charlie Munger was interviewed on the BBC and was asked about how much concern he had for the company’s latest stock price decline. His response:

“Zero. This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by, say, 50%. In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.” [Emphasis ours.]

There will be plenty of commentary online about Buffett’s letter and we don’t intend to distract readers from the source material. There’s just one line from it we’d like to reiterate:

“Although our form is corporate, our attitude is partnership.”

Berkshire’s structure is unusual. It’s a diversified holding company but clearly for many shareholders it has acted extraordinarily well as an investment manager. Berkshire and Buffett have benefited, in turn, from access to genuinely permanent capital and to unusually patient shareholders – a fact Buffett is only too happy to acknowledge. But the bottom line is that the relationship has been symbiotic: a partnership between co-investors, as opposed to an adversarial relationship between lots of mouths needing to be fed, and customers who are second in the queue for capital returns after all those mouths have been fed. As at year-end 2014, Berkshire was a business with $526 billion in assets, with a corporate headquarters employing just 25 people. Now that is decentralised capital allocation.

50 years. A 750,000% return. But the most striking thing about Warren Buffett at Berkshire Hathaway is not even the absurdly enviable track record of demonstrable investment success. The ‘value’ methodology, originally developed by Benjamin Graham, and subsequently adapted by Buffett to take account of Berkshire’s ever-increasing size, is almost entirely transparent, and a matter of historical record, not least in the Berkshire shareholders’ letters. Buffett himself acknowledged the perversity in his 1984 Appendix to Graham’s ‘The Intelligent Investor’:

“I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote ‘Security Analysis’ [and since Ben Graham followed up with ‘The Intelligent Investor’], yet I have seen no trend toward value investing in the 35 years that I’ve practised it. There seems to be some perverse human characteristic that likes to make easy things difficult..

“There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham and Dodd will continue to prosper.”

No, the most striking thing about Benjamin Graham, Warren Buffett, Berkshire Hathaway, and ‘value’ investing is why on earth anybody would want to invest any other way.

No need to say much more than the quotations cited above with regard to the latest non-event from the FTSE 100 index:

The new ‘high’ is only a high in nominal terms. As Merryn Somerset Webb points out, UK retail prices have risen by more than 50% since the last ‘high’ 16 years ago.

As the FT’s John Authers points out, the UK’s annualised real return of 1.4% since the last ‘high’ severely lags behind the rest of the world (2.1%) and even Spain (3.4%). And as Authers rightly also observes, the composition of the FTSE 100 is itself pretty arbitrary – 100 large companies, with particular concentration in banking and commodities, that just happened to list in the UK.

Per Buffett, if you are an ongoing consumer of UK stocks as hamburgers, this is actually bad news. It just means the market is more expensive.

If, like us, you have no interest in index-tracking, and are instead looking for compelling value, this is nothing more than a giant, irrelevant yawn. We are far more interested in what Ben Graham called “the ever-present bargain opportunities in individual securities”. Anglophile investors should be aware that there are currently more attractive sources of value in markets outside the UK and US.

This ‘news’ clearly appeals to those participants in the financial media for whom relevance to the real world comes secondary to the excitement and entertainment engendered by a good sports story.

NEW YORK–Excitement swept the financial world Monday, when a blue line jumped more than 11 percent, passing four black horizontal lines as it rose from 367.22 to 408.85.

It was the biggest single-day gain for a blue line since 1994.

"Even if you extend the blue line's big white box back many vertical lines, you won't find a comparably large jump," said Milton Vogel, a senior analyst with Merrill Lynch. "That line just kept going up, up, up."

The blue line, which had been sluggish ever since the red line started pointing down in April, began its rebound with an impressively pointy 7 percent rise Friday. By noon Monday, it had crossed the second horizontal line from the top for the first time since December.

Ecstatic investors are comparing the blue line to the left side of a very tall, steep blue mountain.

"It's a really steep line," said Larry Danziger, a San Jose, CA, day trader and golf enthusiast. "I stand to make a tremendous amount of money as a result of the steepness of this line."

"It looks like the line's about to shoot out of the box," said Boston-area investor Michael Lupert, enjoying a glass of white zinfandel on the bow of his 30-foot yacht. "I'm definitely going to keep a close eye on this line as it continues to move to the right."

Despite such bullishness, some financial observers are urging caution.

"Given this line's long history of jaggedness, we really should take a wait-and-see approach," Fortune magazine associate editor Charles Reames said. "And even if this important line continues its upward pointiness, we must remember that there are other shapes, colors, numbers, and lines to consider when judging the health of the economy."

Reames also warned that the upward angle of the line, which most analysts agreed was approximately 80 degrees, may have been exaggerated by the way the graph was drawn.

"The stuff that's written along the bottom of the graph is all squished together, making the line look a lot more impressive than it is," Reames said. "Had that same stuff been spread out more, the line would have looked a lot less steep."

Still, most U.S. investors found it hard to contain their enthusiasm as the blue line shot up sharply, outperforming the green line, the yellow line, and even the thriving dotted purple line.

"Typically, the blue line rises or falls no more than 10 in a day," said Beverly Hills plastic surgeon Dr. Jeffrey Gruber. "But Monday, it went up an astonishing 41–and during a time when we have a big red slice showing on our pie charts, no less. We live in a truly remarkable time."

“We are all at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know, by the rules, that at some moment the Black Horsemen will come shattering through the great terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no-one wants to leave while there is still time, so that everyone keeps asking, “What time is it ? What time is it ?” But none of the clocks have any hands.”

- From ‘Supermoney’ by Adam Smith.

It was not supposed to be like this. As we highlighted last week, after the Great Debt Bubble, there has been no Great Deleveraging. In fact, as the McKinsey Global Institute showed in their February 2015 report,

“After the 2008 financial crisis and the longest and deepest global recession since World War II, it was widely expected that the world’s economies would deleverage. It has not happened. Instead..

“Debt continues to grow. Since 2007, global debt has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points.”

Herbert Stein’s Law mandates that if something cannot go on forever, it will stop. The great Austrian economist Ludwig von Mises expressed the same sentiment and came to a somewhat gloomier conclusion:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

As the McKinsey data show, the voluntary abandonment of further credit expansion has clearly not occurred. If Mises is correct, and we are minded to consider that he is, then draw your own conclusions.

We have now become used to so many years of utterly extraordinary monetary experimentation and policy-making on the hoof that there is a danger that Alice-in-Wonderland central banking activity simply gets taken for granted as the natural state of affairs. This is the same type of absurd but incremental behaviour that gets frogs in pans boiled alive with their tacit approval.

Blithe sceptics to this line of thought will no doubt argue that if seven years of making-it-up-as-we-go-along monetary policy hasn’t derailed the system, then perhaps the system won’t get derailed. Perhaps it’s even un-derailable. But this sounds suspiciously like Ben Bernanke’s own flawed thinking when he suggested in July 2005 that

“We’ve never had a decline in house prices on a nationwide basis.”

In other words, because something has never happened before, it never will.

(This from the same person who observed in March 2007 that

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”)

No, the insoluble problem facing every investor today is not just that the system is unsustainable. It clearly is. The problem is that we lack a means of forecasting accurately when the system is likely to break apart. The financial market is a complex, adaptive system, reliant on confidence, the ongoing robustness of which is completely unforecastable. That confidence has been robust is not in question. The creation of trillions of dollars, pounds, euros, yen and renminbi worth of ex nihilo money has yet to dent confidence entirely in an unbacked paper money system (notwithstanding the 345% gain in the dollar price of gold since the start of the millennium).

Just before the turn of the millennium, inside the late Peter L. Bernstein’s excellent history of risk, ‘Against the Gods’, we came across the following quotation by the Swiss mathematician and physicist Daniel Bernoulli: when managing money for wealthy people,

“The practical utility of any gain in portfolio value inversely relates to the size of the portfolio.”

Bernoulli (1700-1782) has a good claim to being one of the world’s first behavioural economists, in that he observed that investment performance for the wealthy is not exactly the same as investment performance for the non-wealthy. For the objectively wealthy, or super-wealthy, any further gain in portfolio value has to be seen in the context of maintaining the original value of the portfolio. Since human beings are typically loss averse, maintaining the original purchasing power of the pot is much more important than generating further incremental gains, especially in an environment where the pursuit of those further gains risks existentially jeopardising that original pot.

US stock markets reached record highs last week. Question: does that make them riskier, or less risky ? We think the former. But for us the question is somewhat academic since we’re not remotely interested in index-tracking. Other investors, however, evidently are. Among the top 10 ETF purchases by customers of Barclays Stockbrokers last week were funds tracking:

The S&P 500 (iShares and Vanguard)

The FTSE 100 (iShares and Vanguard)

The FTSE 250

The Euro Stoxx 50

Japan.

We foresee all kinds of risks in taking indexed exposure to stock markets close to or at their all-time highs. Index-tracking funds offer many things. Relatively low cost market exposure, for one. But as and when stock markets go into reverse, purchasers of low cost trackers will find that they have been penny-wise and pound foolish, because low cost trackers offer precisely zero discernment or discretion when it comes to market direction. If the market goes down, they go down with it.

So rather than tag along for the ride, we much prefer to follow the ‘value’ route (to capital preservation and growth, in that order). Index benchmarking is utterly inappropriate, we would suggest, for the private investor, for whom the ultimate reference rate should be cash, since cash remains the only asset that cannot decline in nominal terms. Or at least that used to be the case, before acronyms like QE, ZIRP and now NIRP (Negative Interest Rate Policy) steamrollered over all assets in their path, like financial terminators.

If we define ‘value’ as inherent quality plus attractive valuation, it has relevance to both debt and equity market investing today. Bond markets as a whole are clearly grotesquely overvalued but may remain so or become even more overvalued because there is an 800lb gorilla in the market determinedly gobbling them up. As of March 2015, the ECB will be buying €60 billion worth every month. We doubt whether there’s that much quality debt on offer in the euro zone. But there may be elsewhere, not least because most of the world’s creditor countries lie outside the euro zone.

In equity markets, we see almost no compelling value in US stocks, which if nothing else are intensely well covered (we mean by number of analysts, not necessarily by quality of coverage) by Wall Street. We see compelling pockets of genuine value, however, in markets like Japan, which simply aren’t well covered by the analyst community, which has been scared off by 20 years of bear market conditions.

We then supplement our debt and equity exposure with uncorrelated investments (namely systematic trend-followers), which we have always regarded as bellwether holdings, and with real assets, notably the monetary metals, gold and silver.

The result: four discrete asset classes that will behave in different ways under different market conditions. High quality debt offers income and a degree of capital preservation (especially in an environment of outright deflation). High quality ‘value’ equity offers income and the potential for attractive capital growth (especially in an environment of modest inflation). Systematic trend-followers are broadly market neutral, but with the potential to deliver outsized gains in an environment of systemic financial distress (most trend-followers generated double or triple digit percentage returns in 2008, for example). And real assets, again, offer the potential to deliver outsized gains in an environment of systemic financial distress or high inflation, or both.

Unlike most of our fund management peers, we accept that we can’t predict the future. Unlike many of them, we are at least preparing for it.

But that brings us back to our initial dilemma. We think the system is desperately unsound, so we take out what insurance we can, whilst still retaining a stake in a variety of markets (on our terms admittedly, rather than according to somebody else’s irrelevant benchmark).

But insurance only works if you have it when the crisis erupts. You don’t buy house insurance after the roof catches fire.

“Popping down to #guardiancoffee later on to order a ‘Toynbee’: short, rich and intensely bitter.”

- Tweet from Robbie Collin (chief film critic, The Telegraph).

We have come a long way since the release of ‘All the President’s Men’. Alan J. Pakula’s 1976 thriller, about the Watergate scandal, may be the first and last film in which the real hero is an institution (The Washington Post, under its principled then executive editor, Ben Bradlee). Or for that matter, not even an institution, so much as an idea: the free press. Robert Redford and Dustin Hoffman may spend their two hours of screentime rushing about having doors slammed in their faces and meeting covert sources in sinister garages, but it’s the idea of the resolute pursuit of truth in the face of administrative obfuscation, peer group indolence, executive greed and a flurry of non-denial denials that lingers long after the titles have rolled. These days, newspapers cut out the middleman and do the bugging themselves.

The concept of a free press has not exactly thrived over subsequent years. Media groups have bulked up into ever more massive, and conflicted, conglomerates. Media channels have proliferated, creating a ‘winner takes most’ competitive environment that has dumbed down everything and crushed audience numbers for anything but the lowest common denominator pap. That catch-all culprit, ‘the Internet’, has facilitated an explosion in the number of amateur content providers that cannot but relentlessly erode the margins of paid-for publishing models. Some of this Schumpeterian creative destruction is to be welcomed. Competition always is. But from an aesthetic and cultural perspective, one is left to wonder whether some industries are better left untouched by those biting digital winds. From the perspective of quality, and in a culture in which time increasingly seems scarcer than money, one sometimes has to ask whether what is free is often far too expensive.

“Labour has almost no leverage over capital any more, which helps explain the rash of “Uber for X” start-ups: they’re nearly all based on the idea that there is a bottomless pool out there of people with smartphones willing to do just about anything (drive a car, go shopping, do laundry, clean an apartment) for $15 an hour. If a company loses one of those workers, it’s no big deal, it just replaces that person with someone else who’s just as good and just as cheap. Now just apply that model to journalists.”

Megan McArdle responded with a less than entirely convincing defence of her own chosen career. Or perhaps she was just expressing Felix Salmon’s concerns from a subtly dissimilar angle:

“..the problem is not competition for eyeballs from new outlets that are writing news in a different, fresher way. The problem is competition for ad dollars from companies that don't produce news at all. Making news is expensive. It's hard to compete against companies that don't bother. Journalism's biggest threat comes from companies like Google and Facebook that cheaply aggregate our expensive content and sell low-cost, demographically targeted ads in huge numbers. They can kill the whole business.”

“As you walk through the front door of the Columbia School of Journalism, the first thing you see is this paragraph, cast on a bronze plaque:

“OUR REPUBLIC AND ITS PRESS WILL RISE OR FALL TOGETHER. AN ABLE, DISINTERESTED, PUBLIC-SPIRITED PRESS, WITH TRAINED INTELLIGENCE TO KNOW THE RIGHT AND COURAGE TO DO IT CAN PRESERVE THAT PUBLIC VIRTUE WITHOUT WHICH POPULAR GOVERNMENT IS A SHAM AND A MOCKERY. A CYNICAL, MERCENARY, DEMAGOGIC PRESS WILL PRODUCE IN TIME A PEOPLE AS BASE AS ITSELF. THE POWER TO MOULD THE FUTURE OF THE REPUBLIC WILL BE IN THE HANDS OF THE JOURNALISTS OF FUTURE GENERATIONS.

“..The first sentence on the bronze plaque that you see when you walk through the front door of the Columbia Journalism School may or may not be true, but it sets a fittingly autocratic, unreflective tone. The second sentence is ungrammatical. The last two sentences offer the sort of grandiose vision of journalism entertained mainly by retired journalists or those assigned to deliver speeches before handing out journalism awards. Highly flattering to all of us, of course, but it would be more true to flip the statement to read: “a cynical, mercenary, demagogic people will produce in time a press as base as itself ...”

The problem with journalism isn’t just the competitive environment; the problem with journalism is journalists. But our focus here is more specifically on journalism relating to matters of finance and investment. Such journalism tends to fall into one of four categories:

The omniscient economics correspondent. Invariably a tortured authoritarian still clinging to the discredited remnants of Keynesian economic theory. “QE does work, we just haven’t done enough of it yet.”

The anti-business zealot. “Everyone should pay their fair share of taxes – especially everybody else.” These social campaigners often come from inherited wealth, and are employed by a tax-advantaged trust.

The clueless tipster. Spanish practices among the gutter press have poisoned the communal well and led to a generalised suspicion by the public that wealth management is little more than organised insider dealing.

It is not enough, and it is certainly not accurate, to say that journalists are merely commentators on financial market action. The commentator at a sports match has no ability whatsoever to affect the outcome of the game. But the financial journalist does, depending on the consumer reach of their ‘platform’.

The irony is that most investors might be better served by cutting out the commentary altogether (an irony of which we are, of course, well aware). The psychologist Paul Andreassen showed that people who receive frequent news updates on their investments earn lower returns than those who get no news. The following is from a 2002 Fast Times article:

“The barrage of information and pseudo-information has been magnified by the explosion in financial news over the past decade. In the late 1980s, psychologist Paul B. Andreassen did a series of experiments with business students at MIT that showed that more news does not necessarily translate into better information. Andreassen divided students into two groups. Each group selected a portfolio of stocks and knew enough about each stock to come up with what seemed like a fair price for it. Then Andreassen allowed one group to see only the changes in the prices of its stocks. Students in that group could buy and sell if they wanted, but all they knew was whether the price of a stock had gone up or down. The second group was allowed to see the changes in price and was also given a constant stream of financial news that supposedly explained what was happening with each stock. Surprisingly, the less-informed group did far better than the group that was given all the news.

“The reason, Andreassen suggested, was that news reports tend to overplay the importance of any particular piece of information. When a stock fell, its fall was typically portrayed as a sign that further trouble lay in wait, while a stock that was on the rise seemed to promise nothing but blue skies ahead. As a result, the students who had access to the news overreacted. Because they took each piece of information as excessively meaningful, they bought and sold far more frequently than the people who were just looking at the price.”

The consistently excellent Wall Street Journal columnist Jason Zweig says he was once asked at a journalism conference how he defined his job. His response:

“My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.”

As Zweig puts it, good advice rarely changes, whereas markets change constantly. “The temptation to pander is almost irresistible. And while people need good advice, what they want is advice that sounds good.”

These are desperate times for investors. Interest rates have been slashed to zero, making a surreal mockery of any sort of savings culture. In some cases they have gone below zero: Bloomberg’s Mark Gilbert points out that negative bond yields are becoming the new normal for many sovereign borrowers, with (clearly terrified) investors willing to pay for the privilege of lending their money to governments. Finland last week auctioned five year notes at minus 0.017%. At least six other countries have five year debt trading at, or below, zero.

At the same time, desperate investors have stampeded into the shares of businesses that seem ostensibly “safe”. In the process, they have bid up the prices of many of those shares to what we consider unsustainable (and probably “unsafe”) levels.

Like us, Zweig sees huge merit in the advice of the legendary value investor, Benjamin Graham:

“The investor’s chief problem – and even his worst enemy – is likely to be himself.”

Another piece of Ben Graham’s advice which we feel is particularly relevant today:

“Investors do not make mistakes, or bad mistakes, in buying good stocks at fair prices. They make their serious mistakes by buying poor stocks, particularly the ones that are pushed for various reasons. And sometimes – in fact very frequently – they make mistakes by buying good stocks in the upper reaches of bull markets.”

That advice could have been written for the market environment of February 2015.

Back to Jason Zweig:

“My role, therefore, is to bet on regression to the mean even as most investors, and financial journalists, are betting against it. I try to talk readers out of chasing whatever is hot and, instead, to think about investing in what is not hot. Instead of pandering to investors’ own worst tendencies, I try to push back. My role is also to remind them constantly that knowing what not to do is much more important than what to do. Approximately 99% of the time, the single most important thing investors should do is absolutely nothing.”

Good luck getting an editor to endorse that message.

There is an intriguing post-script to the Watergate story that touches on the venality of human nature (and therefore, more or less directly, on the biddability of politicians). One of the participants in the decision to break into the offices of the Democratic National Committee was Jeb Stuart Magruder. On hearing that the Watergate burglars had been caught, he responded with a degree of bewilderment consistent with an FT or New York Times economics correspondent:

“How could we have been so stupid ?”

Robert Cialdini points out that the original idea for the break-in came from G. Gordon Liddy, who was in charge of intelligence-gathering for the Committee to Re-elect the President (the appropriately monickered CREEP). His proposal was expensive. It required a budget of $250,000 in untraceable cash, and the involvement of no fewer than ten individuals.

But that wasn’t even his first proposal.

His first plan, proposed two months earlier, involved a $1 million programme, featuring a “chase plane”, break-ins, kidnapping and mugging squads, and a yacht featuring “high-class call girls” to blackmail Democratic politicians. The sort of thing that high-ranking IMF officials wouldn’t necessarily be averse to participating in, when not busy saving the world.

Magruder reports that “no-one was particularly overwhelmed with the project” but “after starting at the grandiose sum of $1 million, we thought that probably $250,000 would be an acceptable figure.. We were reluctant to send him away with nothing.”

You do not need to be a senior Republican activist to master this particular strategy. Any seven-year old girl could proffer a similar negotiating gambit:

“If you want a kitten, ask for a pony.”

So you can choose to trust the newspapers. You can choose to trust the marketing businesses masquerading as asset management firms. You can choose to trust bloggers. But you will probably be well served by shrinking, rather than expanding, your universe of advisory inputs, and focusing on a smaller, more focused network of trusted – and trustworthy – serious and intelligent people. If in doubt, trust no-one.

“Another day, another central bank failure. In a world of currencies backed only by confidence, every failure is masqueraded as success. Like the ballet dancer who transforms the stumble into a pirouette, central bankers, knocked to the ground by market forces, smile and pretend that this was all part of the routine. Financial market participants, having bet everything on the promised omnipotence of central bankers, do indeed seem happy to see genius in every stumble. However a fall is a fall regardless of the style of the descent. So when will investors see that the earth is rapidly approaching and that style is just style?

“..Taking interest rates so negative that they threaten a run on bank deposits should not be seen as success --- it is failure. Creating bank reserves at that pace should not be seen as success --- it is failure. The next failure may well be some government-inspired restriction on capital inflows. Well, you could call such restrictions, and risking the liquidity of banks, monetary success if you like, but then you probably also think it’s a success to throw the ball one yard from the touchline.”

“..The position of the people who had at least nominal responsibility for what was going on was a complex one. One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom.

“Some of those in positions of authority wanted the boom to continue. They were making money out of it, and they may have had an intimation of the personal disaster which awaited them when the boom came to an end. But there were also some who saw, however dimly, that a wild speculation was in progress and that something should be done. For these people, however, every proposal to act raised the same intractable problem. The consequences of successful action seemed almost as terrible as the consequences of inaction, and they could be more horrible for those who took the action.

“A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. Among those who sensed what was happening in early 1929, there was some hope but no confidence that the boom could be made to subside. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. (For nearly a decade the Federal Reserve authorities had been denying their responsibility for the deflation of 1920-1.) The eventual disaster also had the inestimable advantage of allowing a few more days, weeks, or months of life. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market.”

- J.K. Galbraith, ‘The Great Crash 1929’.

“It’s a mess, ain’t it, Sheriff ?”

“If it ain’t, it’ll do ‘til the mess gets here.”

- Dialogue from ‘No country for old men’, by the Coen Brothers and Cormac McCarthy.

There are some time-honoured signs of an impending market top. One of them is that margin debt has peaked. Another is that interest rates are going through the floor. Another is that market breadth is contracting. Another is that the velocity of money is also going through the floor. Another is that Abby Joseph Cohen reckons the stock market is relatively cheap, an opinion which she generously gave at a recent Barrons roundtable. Barrons actually gave us two signs of a market top for the price of one (but then everything’s devalued these days) – their February 6th edition pointed out that the value of fine art sold at auction had quadrupled from $3.9 billion in 2004 to some $16.2 billion in 2014. They tastefully offered readers a choice between the conclusions of malign ‘bubble’ and benign ‘boom’.

The problem is that in an environment of ubiquitous government manipulation, markets can trade at whatever levels central bankers want them to trade at, for a period at least. So we’re not going to be rash enough to call a market top; we’ll merely draw attention to some anecdotal evidence of a certain, how shall we put it, irrational exuberance at work in the US stock market.

We tip our hat to Beijing Perspective and the Wall Street Journal for the recent news that Carmine “Tom” Biscardi is on the hunt for Bigfoot, and is planning an IPO to fund the expedition:

“Mr. Biscardi and his partners hope to raise as much as $3 million by selling stock in Bigfoot Project Investments. They plan to spend the money making movies and selling DVDs, but are also budgeting $113,805 a year for expeditions to find the beast. Among the company’s goals, according to its filings with the Securities and Exchange Commission: “capture the creature known as Bigfoot.”

“Investment advisers caution that this IPO may not be for everyone. For starters, it involves DVDs, a dying technology, said Kathy Boyle, president at Chapin Hill Advisors. Then there is the Sasquatch issue. She reckons only true believers would be interested in such a speculative venture.”

This is a wonderful instance of life imitating art. Note the similarities between the Bigfoot story (which we have to presume is true) and The Onion’s market scoop from November 1999 (the date is instructive), namely

“LAKE ERIE—Seeking to capitalize on the recent IPO rage on Wall Street, Lake Erie-based blue-green algae Anabaena announced Tuesday that it will go public next week with its first-ever stock offering.

“Anabaena, a photosynthesizing, nitrogen-fixing algae with 1999 revenues estimated at $0 billion, will offer 200 million shares on the NASDAQ exchange next Wednesday under the stock symbol ALG. The shares are expected to open in the $47-$49 range.”

It gets better. With eerie genius:

“..Still, many investors said they are unsure whether they would be willing to take even a moderate risk on the stock.

"One thing they're not saying in the prospectus—and I've been through it thoroughly—is that blue-green algae aren't really algae. They're cyanobacteria," said Jeanette MacAlester, a San Francisco-based stockbroker who is strongly advising her clients not to buy ALG. "I don't know if I'd put my money in any bacteria, let alone one that seems to think it has something to hide."

Markets are allowed their petty indiscretions, of course. But these petty indiscretions seem to be piling up. Barry Ritholtz and Bloomberg last week drew attention to the fact that shares of The Grilled Cheese Truck Inc. had commenced trading on the OTCQX marketplace under the ticker GRLD:

“Let's look at the fundamentals of the Ft. Lauderdale, Florida-based company. Based on the 18 million shares outstanding and a recent stock price of $6 the company has a market value of about $108 million. No matter how much you like grilled cheese.. I can't see this as a reasonable valuation.

“If you go to the company’s website, you will learn that “The company currently operates and licenses grilled cheese food trucks in the Los Angeles, CA area and Phoenix, AZ and is expanding into additional markets with the goal of becoming the largest operator in the gourmet grilled cheese space.” You can see an interview with the founder here. The company employs military veterans, and it even lists retired General Wesley Clark as vice chairman.

“However, according to the company’s financial statements, it has about $1 million of assets and almost $3 million in liabilities. In the third quarter of 2014, it had sales of almost $1 million, on which it had a net loss of more than $900,000. The story is much the same for the first nine months of the year: $2.6 million in sales and a loss of $4.4 million.

“But forget the losses for a moment, and make the generous assumption that it will have sales of $4 million this year. This means its shares trade for more than 25 times sales, a very rich valuation.

“Which brings me back to my original comments regarding looking for contrary indicators to my bullish posture. I can't think of a more interesting sign of the old irrational exuberance in equity markets than a publicly traded grilled cheese truck (four in this case) business trading at a $100-million-plus valuation. That sort of thing doesn't happen unless there is significant excess in the markets.”

Any reference to a company seeking to dominate the “gourmet grilled cheese space” is desperately seeking a twin reference to a post we recall from the dotcom deadpool website F******Company.com from circa late 1999:

“Our business strategy is to lose money on every sale but make up for it in volume.”

“The Bank of England paid nearly £3m of taxpayers’ money for a report on whether any of its staff knew about or were involved in illegal manipulation of one of the world’s biggest financial markets.”

- Caroline Binham of The Financial Times, covering allegations of foreign exchange market rigging, and showing how the Bank of England is clearly on top of things, 31st January 2015.

“There are myths and pseudo-science all over the place. I might be quite wrong, maybe they do know all this ... but I don't think I'm wrong, you see I have the advantage of having found out how difficult it is to really know something. How careful you have to be about checking the experiments, how easy it is to make mistakes and fool yourself. I know what it means to know something. And therefore, I see how they get their information and I can't believe that they know it. They haven't done the work necessary, they haven't done the checks necessary, they haven't taken the care necessary. I have a great suspicion that they don't know and that they're intimidating people.”

- Richard Feynman on ‘experts’.

“Sir, Martin Wolf (“Draghi’s bold promise to do what it takes for as long as it takes”) is right to dismiss many of the arguments against QE. But, while QE will not necessarily cause hyperinflation, there is a real risk.

“Central banks have to date simultaneously “printed money” in massive amounts in QE programmes but have then used different mechanisms to “sterilise” the money so that it doesn’t go out in the economy.

“There have been massive increases in reserves held by banks. I have described this as driving with one foot on the throttle and the other on the brake. This means that the money printing hasn’t been inflationary, but it also means that QE has a small bang per buck, working through asset prices rather than real investment. It hasn’t done much for the real economy but has increased stock market prices and the wealth of the 1 per cent.

“The unwinding of the policy needed in the medium term, to avoid hyperinflation, is to sell the assets bought in QE back to the market. So, at some date in the future, bold central banks will need to engineer negative effects more or less equal to the positive effects today. In fact, they will be selling back to the market at a time when interest rates are higher and bond prices lower, taking a loss on the sale.

“The worry is that central banks will find it easier to just let the money flow into the economy at the worst possible time, once the economy has recovered and banks want to lend the money out. The sums are huge, and would then lead to very high inflation.

“The problem with QE is that it’s the wrong monetary policy. It isn’t bold to print money. It will be bold to withdraw it later.”

- Letter to the Financial Times from Mr Jeff Frank, Professor of Economics, Royal Holloway, University of London, UK, 27th January 2015.

Ever heard of Edward G. Leffler ? No, we hadn’t either. But in the words of author and Wall Street Journal columnist Jason Zweig, Leffler was

“the most important person in mutual fund history”.

The financial services industry is not exactly awash with innovations delivering tangible social value. The former Federal Reserve chairman Paul Volcker once suggested that the only useful banking innovation was the ATM machine. Leffler’s claim to fame ? He invented the open-ended fund.

Leffler originally sold pots and pans. But he was not slow to appreciate that selling investments might be more lucrative. In March 1924 he helped launch Massachusetts Investors Trust, the first open-ended fund. Its charter stipulated that “investors could present their shares and receive liquidating values at any time.”

Its impact was similar to that of Henry Ford’s development of the assembly line. It turned asset management into an industrial process. Whereas closed-ended funds contained a fixed amount of capital, open-ended funds had the potential for unlimited growth. As Zweig fairly observes, like any human innovation, the open-ended fund could be used for good, or ill.

He cites Alfred Jaretski, the securities lawyer who helped to draft the Investment Company Act:

“As there is normally a constant liquidation by shareholders who for one reason or another desire to cash in on their shares, the open-end companies must engage in continuous selling of new shares of stock in order to replace the shares so withdrawn…. Under these circumstances, and with keen competition between companies in the sale of their shares, it [is] natural that some questionable practices should [develop]. It furthermore bec[o]me[s] extremely difficult, and in some instances impossible, for any one company or small group of companies to raise standards and at the same time compete with the others.”

At a stroke, the invention of the open-ended fund created a schism in the asset management industry. Institutional investors would thereafter have to make a choice. They could be asset managers, or they could be asset gatherers. But they could not be both. Zweig describes the split as one between an investment firm and a marketing firm. The difference ?

“The marketing firm has a mad scientists’ lab to “incubate” new funds and kill them if they don’t work. The investment firm does not.

The marketing firm charges a flat management fee, no matter how large its funds grow, and it keeps its expenses unacceptably high. The investment firm does not.

The marketing firm refuses to close its funds to new investors no matter how large and unwieldy they get. The investment firm does not.

The marketing firm hypes the track records of its tiniest funds, even though it knows their returns will shrink as the funds grow. The investment firm does not.

The marketing firm creates new funds because they will sell, rather than because they are good investments. The investment firm does not.

The marketing firm promotes its bond funds on their yield, it flashes “NUMBER ONE” for some time period in all its stock fund ads, and it uses mountain charts as steep as the Alps in all its promotional material. The investment firm does none of those things.

The marketing firm pays its portfolio managers on the basis not just of their investment performance but also the assets and cash flow of the funds. The investment firm does not.

The marketing firm is eager for its existing customers to pay any price, and bear any burden, so that an infinite number of new customers can be rounded up through the so-called mutual fund supermarkets. The investment firm sets limits.

The marketing firm does little or nothing to warn its clients that markets do not always go up, that past performance is almost meaningless, and that the markets are riskiest precisely when they seem to be the safest. The investment firm tells its customers these things over and over and over again.

The marketing firm simply wants to git while the gittin’ is good. The investment firm asks, “What would happen to every aspect of our operations if the markets fell by 67% tomorrow, and what would we do about it? What plans do we need in place to survive it?””

So ultimately all fund managers must make a choice. As Zweig puts it,

“You can be mostly a marketing firm, or you can be mostly an investment firm. But you cannot serve both masters at the same time. Whatever you give to the one priority, you must take away from the other.

“The fund industry is a fiduciary business; I recognize that that’s a two-part term. Yes, you are fiduciaries; and yes, you also are businesses that seek to make and maximize profits. And that’s as it should be. In the long run, however, you cannot survive as a business unless you are a fiduciary emphatically first.

“In the short term, it pays off to be primarily a marketing firm, not an investment firm. But in the long term, that’s no way to build a great business. Today, tomorrow, and forever, the right question to ask yourselves is not “Will this sell?” but rather “Should we be selling this?” I will praise every fund company that makes that choice based on what is right for its investors, because I believe that standard of judgment is the right standard.”

There’s a fairly easy way to tell if a firm is a marketing firm or an investment firm. Do you see its advertising on buses, cabs and posters ? Do they have a practically limitless range of funds ? This is not to denigrate marketing firms entirely. But as the financial markets lurch between unprecedented bouts of bad policy, and achieve valuations that we strongly suspect are unlikely to persist, it may be worthwhile to consider the motives of the people charged with managing your money. Are they asset managers, or asset gatherers ? The answer may have some relevance for the sanctity and stability of your portfolio. And for your peace of mind.

“I don’t think there is a problem that this will fix. I think it will just continue to compress yields into negative territory. If that’s the objective it will achieve it. The question is: will we regain European growth momentum and will labour markets pick up in particular outside Germany if we have a programme that buys debt including German sovereign debt ? So the bigger issue is for me a comparison with the US programme. The US QE programme was effective because a large part of the surge of US unemployment towards 10% was cyclical and the Fed provided a federal instrument – there is no risk-sharing because it was federal debt – and intervened in the most liquid market from which everything is priced.

“In Europe we don’t have such a bond market for, say, Eurobonds because the instrument doesn’t exist. It would be a risk-sharing instrument. Europe is not at that stage of political and fiscal integration. So whatever the ECB does they will not have a big impact on unemployment because most of European unemployment, unlike in the US, is not cyclical. European unemployment is high because of structural reasons. It is high because of inflexible labour market and product market structures, of pension systems, of medi-care systems, of a huge amount of government expenditure related to an ageing population. And so the better issue for Europe is to say: ‘we can help buy time as a central bank - governments should do the right thing’. And we’re seeing too little action too late from governments; in my view we’re seeing too much action too much upfront by the central bank and I think they should really work very hard for governments to face their responsibilities rather than taking on ever larger and ever more demanding responsibilities themselves.”

- Axel Weber, former president of the Deutsche Bundesbank, interviewed on Radio 4’s ‘Today’ programme, 22 January 2015, just prior to Mario Draghi’s announcement of a €1.1 trillion ECB money-printing programme.

“The guy with the asset price bubble question.. he is not coming back.”

- Tweet from Zero Hedge during the ECB press conference.

“When you look at Mr Wolf's background ... it becomes clearer why he supports these policies. He's never mortgaged his house to open a small business. He lives in the fairy land of academics that believe printing paper will somehow be a signal to Directors (that have a fiduciary duty to act in the best interest of shareholders) to invest in expanding capacity?! ..that only the omnipotent power of the central planners can save the private sector by artificially holding down the major price signal in a ‘market’ economy.”

- ‘Manfred’, responding to Martin Wolf’s FT piece, ‘Draghi’s bold promise to do what it takes for as long as it takes’, 22 January 2015.

“YOU KNOW THE BULL MARKET IS LONG IN THE TOOTH WHEN

“When….. Start-ups are being started and IPO’s being raised to hunt Bigfoot… Nope… this is not a joke…And nope, this is not something you would see anywhere near market lows.

Start-ups are famous for setting big, hairy goals. Carmine “Tom” Biscardi wants to catch Sasquatch—and is planning an initial public offering to fund the hunt.

Mr. Biscardi and his partners hope to raise as much as $3 million by selling stock in Bigfoot Project Investments. They plan to spend the money making movies and selling DVDs, but are also budgeting $113,805 a year for expeditions to find the beast. Among the company’s goals, according to its filings with the Securities and Exchange Commission: “capture the creature known as Bigfoot.”

Well, that was worth waiting for. Not. Future generations are unlikely to ask, ‘Where were you during the ECB’s announcement of QE, daddy ?’ Primarily because

a) Much of the detail of the stimulus was leaked the day beforehand, and

b) The real event of January was the Swiss National Bank’s capitulation in capping the franc’s peg to the euro.

Axel Weber’s assessment of the futility of euro zone QE is surely sufficiently articulate: a central bank is attempting to solve problems that can only be resolved through government action. A central bank by definition is limited in scope to the monetary sphere. What is required is tough love in the economic policy sphere – in France, in Greece, and elsewhere. Europe lacks the political and fiscal unity for Mario Draghi to do anything other than play games with the printing press and with a load of poor quality debt offering dubious yields. Central banks are not magicians, even if they behave like them.

And the ECB is coming late to the party in any case. In the words of Colin McLean, “the US and UK were dealing with a cyclical downturn, not deep-seated structural failure. In the euro zone, QE might further delay the need for structural reform..”

Financial historian Russell Napier last week discussed the Swiss National Bank’s surprise decision to abandon its own currency peg:

“The Swiss National Bank (SNB) failed to ‘fix’ the exchange rate between the Swiss Franc and the Euro. The simple lesson which investors must learn from this is – central bankers cannot fix very much. The inability of the Swiss National Bank to ‘fix’ the exchange rate will come to be seen as the end of the bull market in the omnipotence of central bankers.”

He went on to highlight some of the other things that investors erroneously believe central banks to have ‘fixed’:

“Central bank policy is creating liquidity. Wrong – the growth in broad money is slowing across the world.

“Central bank policy is allowing a frictionless de-gearing. Wrong – debt to GDP levels of almost every country in the world are rising.

“Central bank policy is creating inflation. Wrong – inflation in most jurisdictions is now back to, or below, the levels recorded in late 2009.

“Central bank policy is fixing key exchange rates and securing growth. Wrong – in numerous jurisdictions, from Poland to China and beyond, this exchange rate intervention is slowing the growth in liquidity and thus the growth in the economy.

“Central bank policy is keeping real interest rates low and stimulating demand. Wrong – the decline in inflation from peak levels in 2011 means that real rates of interest are rising. The growth in demand in most jurisdictions remains very sluggish by historical standards.

“Central bank policy is driving up asset prices and creating a positive wealth impact which is bolstering consumption. Wrong – savings rates have not declined materially.

“Central bank policy is creating greater financial stability. Wrong – whatever positive impact central banks are having on bank capital etc. they have failed to prevent the biggest emerging market debt boom in history. That boom is particularly dangerous because either the borrower or lender is taking huge foreign exchange risks and because a large proportion of that debt has been provided by open-ended bond funds which can be subject to runs.”

The ongoing disaster that is the euro zone is tedious beyond words, so let’s change the subject. The Washington Post last week published a piece on Venezuela (different circus; same clowns) by Matt O’Brien. This is another cautionary tale of what happens to economies when bureaucrats insist on messing around with the price function. Having “defaulted on its people”, Venezuela may now be on the verge of defaulting on its debts.

“It shouldn't be this way. Venezuela, after all, has the largest oil reserves in the world. It should be rich. But it isn't, and it's getting even poorer now, because of economic mismanagement on a world-historical scale. The problem is simple: Venezuela's government thinks it can have an economy by just pretending it does. That it can print as much money as it wants without stoking inflation by just saying it won't. And that it can end shortages just by kicking people out of line. It's a triumph of magical thinking that's not much of one when it turns grocery-shopping into a days-long ordeal that may or may not actually turn up things like food or toilet paper.

“This reality has been a long time coming. Venezuela, you see, has the most oil reserves, but not the most oil production. That's, in part, because the Bolivarian regime, first under Chavez and now Maduro, has scared off foreign investment and bungled its state-owned oil company so much that production has fallen 25 percent since it took power in 1999. Even worse, oil exports have fallen by half. Why? Well, a lot of Venezuela's crude stays home, where it's subsidized to the you-can't-afford-not-to-fill-up price of 1.5 U.S. cents per gallon. (Yes, really). Some of it gets sent to friendly governments, like Cuba's, in return for medical care. And another chunk goes to China as payment in kind for the $45 billion it's borrowed from them.

“That doesn't leave enough oil money to pay bills. Again, the Bolivarian regime is to blame. The trouble is that while it has tried to help the poor, which is commendable, it has also spent much more than it can afford, which is not. Indeed, Venezuela's government is running a 14 percent of gross domestic product deficit right now, a fiscal hole so big that there's only one way to fill it: the printing press. But that just traded one economic problem — too little money — for the opposite one. After all, paying people with newly printed money only makes that money lose value, and prices go parabolic. It's no wonder then that Venezuela's inflation rate is officially 64 percent, is really something like 179 percent, and could get up to 1,000 percent, according to Bank of America, if Venezuela doesn't change its byzantine currency controls.

“Venezuela's government, in other words, is playing whac-a-mole with economic reality. And its exchange-rate system is the hammer. It goes something like this. The Maduro regime wants to throttle the private sector but spend money like it hasn't. Then it wants to print what it needs, but keep prices the same like it hasn't. And finally, it wants to keep its stores stocked, but, going back to step one, keep the private sector in check like it hasn't. This is where its currency system comes in. The government, you see, has set up a three-tiered exchange rate to try to control everything — prices, profits, and production — in the economy. The idea, if you want to call it that, is that it can keep prices low by pretending its currency is really stronger than it is. And then it can decide who gets to make money, and how much, by doling out dollars to importers at this artificially low rate, provided they charge what the government says.

“This might sound complicated, but it really isn't. Venezuela's government wants to wish away the inflation it's created, so it tells stores what prices they're allowed to sell at. These bureaucrat-approved prices, however, are too low to be profitable, which is why the government has to give companies subsidies to make them worthwhile. Now when these price controls work, the result is shortages, and when they don't, it's even worse ones. Think about it like this: Companies that don't get cheap dollars at the official exchange rate would lose money selling at the official prices, so they leave their stores empty. But the ones that are lucky, or connected, enough to get cheap dollars might prefer to sell them for a quick, and maybe bigger profit, in the black currency market than to use them for what they're supposed to. So, as I've put it before, it's not profitable for the unsubsidized companies to stock their shelves, and not profitable enough for the subsidized ones to do so, either..

“.But just like Venezuela has defaulted on its most basic obligations to its people — like, say, laundry detergent — it might also default on its financial ones. It can't afford anything, not food, not diapers, and not bond payments, if oil stays around $50 a barrel. Now, investors have assumed that they'd be able to seize Citgo, which is owned by Venezuela's state-owned oil company, as payment if the country ever defaulted on its debt. But now it looks like that's not true. That, together with falling oil prices, is why credit default swaps, basically debt insurance, on Venezuela's 5-year bonds have exploded the past few months. The fiscal situation is so dire that Citgo, which, remember, supposedly wouldn't count as a part of the Venezuelan state, is planning on taking out $2.5 billion in debt to give to its parent company, which would presumably pass it along to the government. This makes sense, as much as anything does in Venezuela, because Citgo has a higher credit rating than the government, so it can borrow, and if it defaults, it will just be as if the country sold it.

“It's a man-made tragedy, and the men who made it won't fix it. Maduro, for his part, blames the shortages on the "parasitic" private sector, while the food minister doesn't get what the big deal is since he has to wait in line at soccer games.

“So it turns out Lenin wasn't just right that the best way to destroy the capitalist system is to debauch the currency. It's also the best way, as Venezuela can tell you, to destroy the socialist one.”

At last week’s press conference to announce the ECB’s first iteration of QE (if history is any guide, there will be more), Mario Draghi claimed to see no evidence of inflation whatsoever. Perhaps Mario Draghi lets someone else manage his property, stock and bond portfolio.

“I hold all idea of regulating the currency to be an absurdity; the very terms of regulating the currency and managing the currency I look upon to be an absurdity; the currency should regulate itself; it must be regulated by the trade and commerce of the world; I would neither allow the Bank of England nor any private banks to have what is called the management of the currency.”

- Richard Cobden.

“Raj, 33, a London-based photographer and amateur commodities trader who has used Alpari since 2009, said he currently had about £24,000 trapped in his account at the company.

‘It was completely out of the blue, a total shock,’ he said. ‘I’ve never had any issues with them. I’ve been calling and I just keep getting their answerphone.’”

“But the Swiss, not being as smart as the Italians, do not believe in devaluations. You see, in Switzerland, they have never believed in the ‘euthanasia of the rentier’, nor have they believed in the Keynesian multiplier of government spending, nor have they accepted that the permanent growth of government spending as a proportion of gross domestic product is a social necessity.

“The benighted Swiss, just down from their mountains where it was difficult to survive the winters, have a strong Neanderthal bias and have never paid any attention to the luminaries teaching economics in Princeton or Cambridge. Strange as it may seem, they still believe in such queer, outdated notions as sound money, balanced budgets, local democracy and the need for savings to finance investments. How quaint!

“Of course, the Swiss are paying a huge price for their lack of enlightenment. For example, since the move to floating exchange rates in 1971, the Swiss franc has risen from CHF4.3 to the US dollar to CHF0.85 and appreciated from CHF10.5 to the British pound to CHF1.5. Naturally, such a protracted revaluation has destroyed the Swiss industrial base and greatly benefited British producers. Since 1971, the bilateral ratio of industrial production has gone from 100 to 175... in favour of Switzerland.

“And for most of that time Switzerland ran a current account surplus, a balanced budget and suffered almost no unemployment, all despite the fact that nobody knows the name of a single Swiss politician or central banker (or perhaps because nobody knows a single Swiss politician or

central banker, since they have such limited power? And that all these marvellous results come from that one simple fact: their lack of power).

“The last time I looked, the Swiss population had the highest standard of living in the world—another disastrous long term consequence of not having properly trained economists of the true faith.”

- Charles Gave of Gavekal, ‘Swexit !’.

“An increase in the quantity of money only serves to dilute the exchange effectiveness of each franc or dollar; it confers no social benefit whatever. In fact, the reason why the government and its controlled banking system tend to keep inflating the money supply, is precisely because the increase is not granted to everyone equally. Instead, the nodal point of initial increase is the government itself and its central bank; other early receivers of the new money are favoured new borrowers from the banks, contractors to the government, and government bureaucrats themselves. These early receivers of the new money, Mises pointed out, benefit at the expense of those down the line of the chain, or ripple effect, who get the new money last, or of people on fixed incomes who never receive the new influx of money. In a profound sense, then, monetary inflation is a hidden form of taxation or redistribution of wealth, to the government and its favoured groups, and from the rest of the population.. every change in the supply of money stimulated by government can only be pernicious.”

- Murray Rothbard.

“The longer the boom of inflationary bank credit continues, the greater the scope of malinvestments in capital goods, and the greater the need for liquidation of these unsound investments. When the credit expansion stops, reverses, or even significantly slows down, the malinvestments are revealed. Mises demonstrated that the recession, far from being a strange, unexplainable aberration to be combated, is really a necessary process by which the market economy liquidates the unsound investments of the boom, and returns to the right consumption / investment proportions to satisfy consumers in the most efficient way.

“Thus, in contrast to the interventionists and statists who believe that the government must intervene to combat the recession process caused by the inner workings of free market capitalism, Mises demonstrated precisely the opposite: that the government must keep its hands off the recession, so that the recession process can quickly eliminate the distortions imposed by the government-created inflationary boom.”

- Murray Rothbard, again.

“I don’t know what’s going to happen in Europe but there is one thing I am certain about – eventually, someone is going to take a big loss. As investors, the most important thing we can do is to make sure that we aren’t the parties taking that loss.”

“The designers of the good ship euro wanted to create the greatest liner of the age. But as everybody now knows, it was fit only for fair-weather sailing, with an anarchic crew and no lifeboat. Its rules of economic seamanship were rudimentary, and were broken anyway. When it struck a reef two years ago, the water flooded one compartment after another.. European officials now recognise the folly of creating the euro without preparing for trouble. It would be wise to be planning now for what to do if it sinks.. Even now, after decades of “European construction”, many Eurocrats cannot conceive of the euro as a wreck. Those who have worked hardest to keep it afloat are exhausted and know it is not in their power to save it anyway.”

- Charlemagne in ‘The Economist’, November 2011.

“Sir, It was a very cruel joke to publish Richard Barwell‟s recent letter (“Exit from first round of QE now seems premature”), particularly as it followed hot on the heels of Fed chairman Ben Bernanke’s announcement of so much more of the stuff. It was certainly a delicious coinage of Mr Barwell’s to suggest that this argument “makes no sense in theory”. This reminded me of those scientists who also contend that bumble bees cannot fly – in theory. Can I suggest that the FT letters page imposes some kind of moratorium on self-interested and highly conflicted “advice” from an academic school – economics – that having brought us to the brink, is now in danger of theorising itself into total absurdity ? To read that Mr Barwell is employed by the one organisation that has done more than any other to destabilise if not destroy the UK financial system – RBS – was the icing on this particularly ironic cake.

“QE does nothing more than put yet more capital into the hands of bankers who can then either play in the markets with it, or sit on it. In doing so, it also devalues its practitioners’ currencies versus those of regimes that have fundamentally sound economic policy. If our government and central bank wanted to do something properly constructive with all this newly created money, perhaps it could invest it into our country’s jaded infrastructure, rather than inflating further asset bubbles, the “wealth effect” of which is likely to be wholly illusory.”

- Tragically unpublished letter to the Financial Times from the author, November 2010.

“What really broke Germany was the constant taking of the soft political option in respect of money.”

“Across the world, and certainly across Twitter, people are showing solidarity with the murdered journalists of satirical French magazine Charlie Hebdo, proclaiming in black and white that they too share the values that got the cartoonists killed. Emotionally and morally I am entirely with that collective display — but actually I and almost all those declaring their solidarity are not Charlie because we simply do not have their courage.

“Charlie Hebdo’s leaders were much, much braver than most of us; maddeningly, preposterously and — in the light of their barbarous end — recklessly brave. The kind of impossibly courageous people who actually change the world. As George Bernard Shaw noted, the “reasonable man adapts himself to the world while the unreasonable man persists in trying to adapt the world to himself”, and therefore “all progress depends upon the unreasonable man”. Charlie Hebdo was the unreasonable man. It joined the battle that has largely been left to the police and security services..

“It is an easy thing to proclaim solidarity after their murder and it is heart-warming to see such a collective response. But in the end — like so many other examples of hashtag activism, like the #bringbackourgirls campaign over kidnapped Nigerian schoolchildren — it will not make a difference, except to make us feel better. Some took to the streets but most of those declaring themselves to be Charlie did so from the safety of a social media account. I don’t criticise them for wanting to do this; I just don’t think most of us have earned the right.”

“But the rest of us, like me, who sit safely in an office in western Europe — or all those in other professions who would never contemplate taking the kind of risks those French journalists took daily — we are not Charlie. We are just glad that someone had the courage to be.”

- Robert Shrimsley in the Financial Times, 8 January 2015.

“Your right to swing your arms ends just where the other man’s nose begins.”

- Zechariah Chafee , Jr.

“I do not agree with what you have to say, but I’ll defend to the death your right to say it.”

- Voltaire.

On All Saint’s Day, 1st November 1755, an earthquake measuring roughly 9 on the Richter scale struck the Portuguese capital, Lisbon. At least 30,000 people are estimated to have perished. A little over half an hour after the original quake, a tsunami engulfed the lower half of the city. Those not affected by the quake or the tsunami were then beset by a succession of fires, which burned for five days. 85% of Lisbon’s buildings were destroyed. Ripples from the earthquake were felt far afield. Finland and North Africa felt aftershocks; a smaller tsunami made landfall in Cornwall.

Such destruction had a follow-on impact, in both philosophical and theological terms. In June 1756, the Inquisition responded with an auto-da-fé – a witch-hunt, effectively, for heretics.

One, much-loved, novel happens to cover both of these events, along with a third, from March 1757, when the British Admiral John Byng was executed for cowardice in the face of the French enemy at the battle of Minorca. This inspired the famous line, “Dans ce pays-ci, il est bon de tuer de temps en temps un amiral pour encourager les autres”: “In this country, it is wise to kill an admiral from time to time to encourage the others.”

That novel was written by a Frenchman, François-Marie Arouet, in 1758. We know him better today by his nom de plume: Voltaire. And his satirical magnum opus that catalogued these various disasters was called ‘Candide’.

‘Candide’ is a triumph of the style of novel best described as ‘picaresque’. It’s crammed with eminently quotable lines – the ‘Pulp Fiction’ of its day, if you will. Candide himself is a naïf who wanders with wide-eyed innocence through a savage and corrupt world. But in its Professor Pangloss it offers us the perfect encapsulation of today’s rogue economist, the unworldly and confused academic whose misguided practice of a false science has dreadful implications for the rest of us. A good modern-day example would be Martin Wolf, the FT’s chief economics correspondent, who on Friday complained about the UK’s property planning regime being “Stalinist”. Mr Wolf should try looking in the mirror more often – he is an ardent supporter of Stalinist monetary policy, for example.

As investors we are all now the subjects of a grotesque monetary experiment. This experiment has never been tried before, and its outcome remains uncertain. The unproven thesis, however, runs something like this: six years into a second Great Depression, the only “solution” is for central banks to print ever greater amounts of money. Somehow, gifting free money to the banks that helped precipitate the crisis will lead to a ‘trickle down’ wealth effect. Instead of impoverishing those with savings, inflation will be some kind of miraculous curative, and it must be encouraged at all costs.

It bears repeating: we are in an extraordinary financial environment. In the words of the fund managers at Incrementum AG,

“We are currently on a journey to the outer reaches of the monetary universe.”

On January 25th, Greece goes to the polls. Greek voters face the unedifying choice of re-electing the buffoons who got the country into its current mess or electing rival buffoons issuing comparably ridiculous economic promises that cannot possibly be fulfilled. Voltaire would be in his element. But Greece is hardly alone. Just about every government in the euro zone fiddled its figures to qualify for membership of this not particularly exclusive club, and now the electorate of the euro zone is paying the price. Not that any of this is new news; the euro zone has been in crisis more or less since its inception. If it hadn’t been for sterling’s inglorious ethnic cleansing from the exchange rate mechanism in September 1992, the UK might be in the same boat. Happily, for once, the market was allowed to prevail. The market triumphed over the cloudy vision of bewildered politicians, and the British chancellor ended up singing in the bath. (That he had been a keen advocate of EMU and the single currency need not concern us – consistency or principles are not necessarily required amongst politicians.)

But the market – a quaint concept of a bygone age – has largely disappeared. It has been replaced throughout the West by bureaucratic manipulation of prices, in part known as QE but better described as financial repression. Anyone who thinks the bureaucrats are going to succeed in whatever Panglossian vision they’re pursuing would be well advised to read Schuettinger and Butler’s ‘Forty centuries of wage and price controls’. The clueless bureaucrat has a lot of history behind him. In each case it is a history of failure, but history is clearly not much taught – and certainly not respected – in bureaucratic circles these days. The Mises bookstore describes the book as a “popular guide to ridiculous economic policy from the ancient world to modern times. This outstanding history illustrates the utter futility of fighting the market process through legislation. It always uses despotic measures to yield socially catastrophic results.”

The subtitle of Schuettinger and Butler’s book is ‘How not to fight inflation’. But inflation isn’t the thing that our clueless bureaucrats are fighting. The war has shifted to one against deflation – because consumers clearly have to be protected from everyday lower prices.

Among the coverage of last week’s dreadful events in Paris, there has been surprisingly little discussion about the belief systems of religions other than Islam. We think that Stephen Roberts spoke a good deal of sense when he remarked to a person of faith:

“I contend that we are both atheists. I just believe in one fewer god than you do. When you understand why you dismiss all the other possible gods, you will understand why I dismiss yours.”

There is altogether too much worship of false gods in our economy and what remains of our market system. Some hubris amongst our technocratic “leaders” would be most welcome. Until we get it, the requirement to concentrate on only the most explicit examples of value remains the only thing in investment that makes any sense at all.

“Sir, John Authers, in Loser’s Game (The Big Read, December 22), could have delved deeply into the flaws in the asset management business as it has evolved in recent decades, rather than accepting the industry’s own terms or focusing on tweaks to “active” management that might improve results..

“Mr Authers could also have challenged the bureaucratic thinking and methods asset management has adopted in the course of chasing its “bogeys”, starting with the Big Ideas.. Then there are the model portfolios, relative-weightings, “style drift”, investment committees, the requirement to be fully invested and so on — all bog down decision-making and most have nothing to do with genuine investing. In adopting these practices the fund management business has created a recipe for mediocrity.

“In investing, it is never a good idea to do what everyone else is doing. Piling into passive index funds during a year of decidedly poor relative results for active managers, and especially after a long period of rising security prices is likely to lead to future disappointment, just as it did in 1999. This leads us to another line of inquiry for Mr Authers: even assuming “beating” an index is worthwhile, why must we do it all of the time? It is a paradox of investment that in order to do well in the long run, you sometimes have to do “poorly” in the short run. You have to accept the fact that often you will not “beat” an index; sometimes you don’t even want to — think of the Nasdaq in 1999, for example..”

- Letter to the FT from Mr. Dennis Butler, December 30, 2014.

A happy new year to all readers.

For historians, there are primary sources and secondary sources. Primary sources are the original documents that point to the raw history, like the original Magna Carta, for example. Secondary sources are effectively historical derivatives – they incorporate interpretation and analysis. In financial markets, the equivalent of primary sources are prices – the only raw data that speak unequivocally of what occurred by way of financial exchange between buyer and seller. Everything else amounts to interpretation and analysis, and must by definition be regarded as subjective. So-called fundamentals, therefore, are subjective. There is the price – and everything else is essentially chatter.

It says much for the quality and depth of our mainstream media that one of the most insightful and thought-provoking pieces of social and cultural analysis of the last year came in the form of a 5 minute essay within a satirical news review of 2014. The piece in question was by the cult documentary maker Adam Curtis and you can watch it here. The following extracts are taken directly from the film:

“So much of the news this year has been hopeless, depressing, and above all, confusing. To which the only response is to say, "oh dear."

“What this film is going to suggest is that that defeatist response has become a central part of a new system of political control. And to understand how this is happening, you have to look to Russia, to a man called Vladislav Surkov, who is a hero of our time.

“Surkov is one of President Putin's advisers, and has helped him maintain his power for 15 years, but he has done it in a very new way.

“He came originally from the avant-garde art world, and those who have studied his career, say that what Surkov has done, is to import ideas from conceptual art into the very heart of politics.

“His aim is to undermine people’s perceptions of the world, so they never know what is really happening.

“Surkov turned Russian politics into a bewildering, constantly changing piece of theatre. He sponsored all kinds of groups, from neo-Nazi skinheads to liberal human rights groups. He even backed parties that were opposed to President Putin.

“But the key thing was, that Surkov then let it be known that this was what he was doing, which meant that no-one was sure what was real or fake. As one journalist put it: "It is a strategy of power that keeps any opposition constantly confused."

“A ceaseless shape-shifting that is unstoppable because it is undefinable..

“But maybe, we have something similar emerging here in Britain. Everything we're told by journalists and politicians is confusing and contradictory. Of course, there is no Mr. Surkov in charge, but it is an odd, non-linear world that plays into the hands of those in power.

“British troops have come home from Afghanistan, but nobody seems to know whether it was a victory or whether it was a defeat.

“Ageing disk jockeys are prosecuted for crimes they committed decades ago, while practically no one in the City of London is prosecuted for the endless financial crimes that have been revealed there..

“..the real epicentre of this non-linear world is the economy, and the closest we have to our own shape-shifting post-modern politician is [U.K. Chancellor of the Exchequer] George Osborne.

“He tells us proudly that the economy is growing, but at the same time, wages are going down.

“He says he is reducing the deficit, but then it is revealed that the deficit is going up.

“But the dark heart of this shape-shifting world is Quantitative Easing. The government is insisting on taking billions of Pounds out of the economy through its austerity programme, yet at the very same time it is pumping billions of Pounds into the economy through Quantitative Easing, the equivalent of 24,000 Pounds for every family in Britain.

“But it gets even more confusing, because the Bank of England has admitted that those billions of Pounds are not going where they are supposed to. A vast majority of that money has actually found its way into the hands of the wealthiest five percent in Britain. It has been described as the biggest transfer of wealth to the rich in recent documented history.

“It could be a huge scandal, comparable to the greedy oligarchs in Russia. A ruthless elite, siphoning off billions in public money. But nobody seems to know.

“It sums up the strange mood of our time, where nothing really makes any coherent sense. We live with a constant vaudeville of contradictory stories that makes it impossible for any real opposition to emerge, because they can't counter it with any coherent narrative of their own.

“And it means that we as individuals become ever more powerless, unable to challenge anything, because we live in a state of confusion and uncertainty. To which the response is: Oh dear. But that is what they want you to say.”

The start of the New Year is traditionally a time for issuing financial forecasts. But there seems little point in doing so given the impact of widespread financial repression on the price mechanism itself. Are prices real, or fake ? The cornerstone of the market structure is the price of money itself – the interest rate. But interest rates aren’t being set by a free market. Policy rates are being kept artificially low by central banks, while the term structure of interest rates has been hopelessly distorted by monetary policy conducted by those same central banks. Inasmuch as ‘real’ investors are participating in the bond market at all, those institutional investors have no personal skin in the game – they are economic agents with no real accountability for their actions. Other institutional players can be confidently assumed simply to be chasing price momentum – they likely have no ‘view’ on valuation, per se. The world’s bond markets have become a giant Potemkin village – nobody actually lives there.

So of the four asset classes to which we allocate, three of them offer at least some protection against the material depradations and endless price distortions of the State. ‘Value’ listed equities give us exposure to the source of all fundamental wealth – the actions of the honest entrepreneur. Systematic trend-following funds are the closest thing we can find to truly uncorrelated investments – and we note how 2014 saw a welcome return to form. The monetary metals, gold and silver, give us Stateless money that cannot be printed on demand by the debt-addicted. We are slowly coming to appreciate the counsel of a friend who suggested that the merit of gold lies not in its price so much as in its ownership. What matters is that you own it. (It also matters why.) Which leaves debt. Objectively high quality debt – a small market and getting smaller by the day.

The practice of sensible investment becomes difficult when our secondary information sources (“fundamentals”) are inherently subjective. It becomes almost impossible when our primary information sources (prices) can’t be trusted because they have politicians’ paw-prints all over them. “Nothing really makes any coherent sense.. We live with a constant vaudeville of contradictory stories.. We live in a state of confusion and uncertainty.” If the pursuit of certainty is absurd, the only rational conclusion is to acknowledge the doubt, and invest accordingly.

“Except for US Treasuries, what can you hold ? US Treasuries are the safe haven. For everyone, including China, it is the only option.. Once you [Americans] start issuing $1 trillion - $2 trillion.. we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

- Luo Ping, official at the China Banking Regulatory Commission, addressing an audience in New York in early 2009.

“This is a big change and it cannot happen too quickly, but we want to use our reserves more constructively by investing in development projects around the world rather than just reflexively buying US Treasuries. In any case, we usually lose money on Treasuries, so we need to find ways to improve our return on investment.”

The Commentary will shortly be off for its winter break. We wish all clients and readers a merry Christmas and a peaceful and prosperous New Year. See you in 2015.

“Mutually assured destruction” was a doctrine that rose to prominence during the Cold War, when the US and the USSR faced each other with nuclear arsenals so populous that they ensured that any nuclear exchange between the two great military powers would quickly lead to mutual overkill in the most literal sense. Notwithstanding the newly dismal relations between the US and Russia, “mutually assured destruction” now best describes the uneasy stand-off between an increasingly indebted US government and an increasingly monetarily frustrated China, with several trillion dollars’ worth of foreign exchange reserves looking, it would now appear, for a more productive home than US Treasury bonds of questionable inherent value. Until now, the Chinese have had little choice where to park their trillions, because only markets like the US Treasury market (and to a certain extent, gold) have been deep and liquid enough to accommodate their reserves.

The FT article, by James Kynge and Josh Noble, points to three related policy developments on the part of the Chinese authorities:

1) China’s appetite for US Treasury bonds is on the wane;

2) China is ramping up its overseas development programme for both financial and geopolitical reasons;

3) The promotion of the renminbi as a global currency “is gradually liberating Beijing from the dollar zone”.

The US has long enjoyed what Giscard d’Estaing called the “exorbitant privilege” of issuing a currency that happens to be the global reserve currency. The FT article would seem to suggest that the days of exorbitant privilege may be coming to an end – to be replaced, in time, with a bi-polar reserve currency world incorporating both the US dollar and the renminbi. (The euro might be involved, if that demonstrably dysfunctional currency bloc lasts long enough.) Here’s a quiz we often wheel out for prospective clients:

1) Which country is the world’s largest sovereign miner of gold ?

2) Which country doesn’t allow an ounce of that gold to be exported ?

3) Which country has advised its citizenry to purchase gold ?

Three questions. One answer. In each case: China. Is it plausible that, at some point yet to be determined, a (largely gold-backed) renminbi will either dethrone the US dollar or co-exist alongside it in a new global currency regime ? We think the answer is yes, on both counts.

Meanwhile the US appears to be doing everything in its power to hasten the relative decline of its own currency. There is a new ‘big figure’ to account for the size of the US national debt, which now stands at some $18 trillion. That only accounts for the on-balance sheet stuff. Factor in the off-balance sheet liabilities of the US administration and pretty soon you get to a figure (un)comfortably north of $100 trillion. It will never be paid back, of course. It never can be. The only question is which poison extinguishes it: formal repudiation, or informal inflation. Perhaps we, or future generations, get both.

So the direction of travel of two colossal ‘macro’ themes is clear (the insolvency of the US administration, and its replacement on the geopolitical / currency stage by that of the Chinese). The one question neither we, nor anybody else, can answer precisely is: when ?

There are other statements that beg the response: when ? Government bond yields have already entered a ‘twilight zone’ of practical irrelevance to rational and unconstrained investors. But when do they go into reverse ? When will the world’s most frustrating trade (‘the widow-maker’, i.e. shorting the Japanese government bond market) start finally to work ? When will investors be able to enter or re-enter stock markets without having to worry about the malign impact of central bank price support mechanisms (a polite way of describing asset price boosterism and state-sanctioned inflationism) ?

Here’s another statement that begs the response: when ? The US stock market is already heavily overvalued by any objective historical measure. When is Jack Bogle, the founder of the world’s largest index-tracking business, Vanguard, going to acknowledge that advocating 100% market exposure to one of the world’s most expensive markets, at its all-time high, might amount to something akin to “overly concentrated investment risk” ? Barron’s Magazine asks broadly the same question.

Lots of questions, and not many definitive answers. Some suggestions, though:

At the asset class level, diversification – by geography, and underlying asset type – makes more sense than ever, unless you strongly believe you can anticipate the actions and intentions of central banking bureaucrats throughout the world. Warren Buffett once said that wide diversification was only required when investors do not understand what they are doing. We would revise that statement to take into account the unusual risks at play in the global macro-economic arena today: wide diversification is precisely required when central bankers do not understand what they are doing.

Expanding on the diversification theme, explicit value (“cheapness”) today only exists meaningfully in the analytically less charted territories of the world. @RobustCap highlights the discrepancy between valuations in the US stock market versus those of Russia, China and emerging Europe. There are clearly ‘fundamental’ and corporate governance reasons that account for some of this discrepancy, but in our view certainly not the entirety of it. Some examples:

CountryC.A.P.E.P/EP/B

North America 23.8 20.2 2.7x

Russia 5.2 6.8 0.7x

China 17.2 6.9 1.1x

Austria 6.8 43.4 0.9x

In emerging and ‘challenged’ markets, there are always reasons not to invest. Nevertheless, price is what you pay and value is what you get.

Some form of renminbi exposure makes total sense as part of a diversified currency portfolio.

US equities should be selected, if at all, with extreme care; ditto the shares of global mega-cap consumer brands, where valuations point strongly to the triumph of the herd.

And whatever their direction of travel in the short to medium term, US Treasuries at current levels make no sense whatsoever to the discerning investor. The same holds for Gilts, Bunds, JGBs, OATs.. Arguments about Treasury yields reverting to a much lower longer term mean completely ignore a) the overwhelming current and future oversupply, and b) the utter lack of endorsement from one of their largest foreign holders. Foreign holders of US Treasuries, you have been warned. The irony is that many of you are completely price-insensitive so you will not care.

There are other reasons to be fearful of stock market valuations, notably in pricey western markets, over and above concerns over the debt burden. As Russell Napier points out in his latest ‘The Solid Ground’ piece,

“In 1919-1921, 1929-1932, 2000-2003, 2007-2009 it was not a resurgence in wages, Fed-controlled interest rates or corporate taxes which produced a collapse in corporate profits and a bear market in equities. On those four occasions equity investors suffered losses of 32%, 85%, 41% and 51% respectively despite the continued dormancy of labour, creditors and the state. It was deflation, or the fear of deflation, which cost equity investors so much. There is a simple reason why deflation has always been so damaging to corporate profits and equity valuations: it brings a credit crisis..

“Investors forget at their peril what can happen to the credit system in a highly leveraged world when cash-flows, whether of the corporate, the household or the state variety, decline. In a deflationary world credit is much more difficult to access, economic activity slows and often one very large institution or country fails and creates a systemic risk to the whole system. The collapse in commodity prices and Emerging Market currencies in conjunction with the general rise of the US$ suggests another credit crisis cannot be far away. With nominal interest rates already so low, monetary remedies to a credit seizure today would be much less effective. Such a shock, after five and a half years of QE, might suggest that the patient does not respond to this type of medicine.”

And since Christmas fast approaches, we can’t speak to the merits of frankincense and myrrh, but gold, that famous “6,000 year old bubble”, has always been popular, but rarely more relevant to the investor seeking a true safe haven from forced currency depreciation and an ever vaster mountain of unrepayable debt.

“What will futurity make of the Ph.D. standard ? Likely, it will be even more baffled than we are. Imagine trying to explain the present-day arrangements to your 20-something grandchild a couple of decades hence – after the Crash of, say, 2016, that wiped out the youngster’s inheritance and provoked a central bank response so heavy-handed as to shatter the confidence even of Wall Street in the Federal Reserve’s methods.

“I expect you’ll wind up saying something like this: “My generation gave former tenured economics professors discretionary authority to fabricate money and to fix interest rates. We put the cart of asset prices before the horse of enterprise. We entertained the fantasy that high asset prices made for prosperity, rather than the other way around. We actually worked to foster inflation, which we called ‘price stability’ (this was on the eve of the hyperinflation of 2017). We seem to have miscalculated.”

- Excerpt from James Grant’s November 2014 Cato speech. Hat-tip to Alex Stanczyk.

You can be for gold, or you can be for paper, but you cannot possibly be for both. It may soon be time to take a stand. The arguments in favour of gold are well known, and just as widely ignored by the paperbugs, who have a belief system at least as curious because its end product is destined to fail – we just do not know precisely when. The price of gold is weakly correlated to other prices in financial markets, as the last three years have clearly demonstrated. Indeed gold may be the only asset whose price is being suppressed by the monetary authorities, as opposed to those sundry instruments whose prices are being just as artificially inflated to offer the illusion of health in the financial system (stocks and bonds being the primary financial victims). Beware appearances in an unhinged financial system, because they can be dangerously deceptive. It is quite easy to manipulate the paper price of gold on a financial futures exchange if you never have to make delivery of the physical asset and are content to play games with paper. At some point that will change. Contrary to popular belief, gold is supremely liquid, though its supply is not inexhaustible. It is no-one’s liability – this aspect may be one of the most crucial in the months to come, as and when investors learn to start fearing counterparty risk all over again. Gold offers a degree of protection against uncertainty. And unlike paper money, there are fundamental and finite limits to its creation and supply.

What protection ? There is, of course, one argument against gold that seems to trump all others and blares loudly to sceptical ears. Its price in US dollars has recently fallen. Not in rubles, and not perhaps in yen, of course, but certainly in US dollars. Perhaps gold is really a currency, then, as opposed to a tiresome commodity ? But the belief system of the paperbug dies hard.

The curious might ask why so many central banks are busily repatriating their gold ? Or why so many Asian central banks are busily accumulating it ? It is surely not just, in Ben Bernanke’s weasel words, tradition ?

If you plot the assets of central banks against the gold price, you see a more or less perfect fit going back at least to 2002. It is almost as if gold were linked in some way to money. That correlative trend for some reason broke down in 2012 and has yet to re-emerge. We think it will return, because 6,000 years of human history weigh heavily in its favour.

Or you can put your faith in paper. History, however, would not recommend it. Fiat money has a 100% failure rate.

Please note that we are not advocating gold to the exclusion of all else within the context of a balanced investment portfolio. There is a role for objectively creditworthy debt, especially if deflation really does take hold – it’s just that the provision of objectively creditworthy bonds in a global debt bubble is now vanishingly small. There is a role for listed businesses run by principled, decent management, where the market’s assessment of value for those businesses sits comfortably below those businesses’ intrinsic worth. But you need to look far and wide for such opportunities, because six years of central and commercial banks playing games with paper have made many stock markets thoroughly unattractive to the discerning value investor. We suggest looking in Asia. There is a role for price momentum strategies which, having disappointed for several years, though not catastrophically so, now appear to be getting a second wind, from the likes of deflating oil prices, periphery currencies, and so on.

As investors we are all trapped within a horrifying bubble. We must play the hand we’ve been dealt, however bad it is. But there are now growing signs of end-of-bubble instability. The system does not appear remotely sound. Since political vision in Europe, in particular, is clearly absent, the field has been left to central bankers to run amok. The only question we cannot answer is: precisely when does the centre fail ? The correct response is to recall the words of the famed value investor Peter Cundill, when he confided in his diary:

“The most important attribute for success in value investing is patience, patience, and more patience. THE MAJORITY OF INVESTORS DO NOT POSSESS THIS CHARACTERISTIC.”

But the absence of patience by the majority of investors is fine, because it leaves more money on the table for the rest of us. The only question remaining is: in what exact form should we hold that money ?

Be patient, and do please set aside thirty minutes to listen to James Grant’s quietly passionate and wonderfully articulate Cato Institute speech. It will be time well spent.

“Sir, Martin Wolf in his article “Radical cures for unusual economic ills” suggests an abandonment of free market capitalism, as it has been practised these past couple of hundred years, and instead wants some kind of witch-doctoring economic quackery to take its place. Savings are the capital that forms the basis of capitalism. You can’t have capitalism without capital. And without interest rates pegged at levels that encourage savings, you won’t generate the quantities of savings necessary to sustain a capitalist economy.

“We need to stop the insanity. For example, savings rates in the US fluctuate around zero per cent along with interest rates set by the Fed. To hide this stab in the back to savers, the Federal Reserve simulates savings with ersatz monetary hokum like quantitative easing designed to create the illusion of a solvent economy that can run fine without actually having any savings.

“Despite the evidence proving the failure of this approach, Mr Wolf continues to recommend attacking savers, including the so-called “savings glut” held by countries in the east that hold large cash reserves as protection against the reckless policies like those suggested by Mr Wolf, who appears ignorant of the history of why these reserves exist in the first place: to protect these countries and currencies from the unorthodox (read “failed”) policy suggestions of pundits and academics who would do us all a great favour by simply admitting that their prescriptions for global growth have completely, unequivocally, failed.”

- Letter to the Financial Times from Mr Max Keiser, London W1, 28 November 2014.

So the Swiss have decided not to force their central bank into underpinning its reserves with harder assets than increasingly worthless euros. At least they had the chance to vote. But in the bigger picture, the rejection of the “Save Our Swiss Gold” initiative flies in the face of a broader trend towards repatriation and consolidation of sovereign bullion holdings – following on the heels of similar attempts by the Bundesbank, the Dutch central bank, for example, recently announced that it had moved a fifth of its total gold reserves from New York to Amsterdam. And the physical metal continues its inexorable exodus eastwards, into stronger hands that are unlikely to relinquish it any time soon.

The Swiss vote was preceded by some fairly extraordinary black propaganda, most notoriously by Willem Buiter of the banking organisation that now styles itself ‘Citi’. Once again we were treated to the intriguing claim that gold is nothing more than “a six thousand year-old bubble”, and a “fiat commodity currency” (whatever that might mean) that has “insignificant intrinsic value”. Izabella Kaminska for the FT’s Alphaville republished much of Buiter’s ‘research’; the resultant to-and-fro between FT readers on the paper’s website makes for a fascinating scrap between goldbugs and paperbugs. Among the highlights was Vlady, who wrote:

“When a social construct (gold as money) survives for 6,000 years I would expect curious people to inquire as to whether it is tied to some immutable underlying law, or otherwise investigate if there is something more here than meets the eye. Not so curiously inclined, our court economists prefer to write this off as a 6,000 year old delusion. That says a lot about the sorry state of the economics discipline today.”

Another was the artfully named ‘Financially Repressed by Central Banks’, who wrote:

“I think that the reason bankers and governments dislike gold backed hard currencies is that it limits their ability to devalue their fiat currency and redistribute wealth in order to stay in power.

The governmental solution to all the debt in the world is to try to inflate it away and slowly take money away from the people via currency depreciation and manipulating interest rates such savers and forced owners of government debt (such as pension schemes) make a negative return.

I think this is robbery - Pure and simple. The market is not free, it is controlled.

A move away from fiat currency and back to using gold backed currency would remove the ability of governments to print money and this in turn would remove their ability constantly try to avoid facing the consequences of building up huge debts, which in term means they would have to face the music and actually have a plan to repay it.

It is the central banks and private banks who are complicit in this government sponsored process of stealing and their rewards are their ability themselves big bonuses and the occasional tax payer funded rescue..

Mr Buiter works for a bank. What a surprise that he dislikes Gold and is presumably very concerned when a central bank (Switzerland) looks like it might do something silly like buying some gold. Don't they realize that in acknowledging the concerns of holders of fiat currency (the people of Switzerland) that their actions might encourage others to think that maybe just maybe fiat currency is not quite as useful as gold?

/ rant on / I am not a gold bug, but I am a hard working tax payer who is getting pretty fed up with having my savings earning no interest and possibly being devalued (see Japan) and of not being able to find any sensible place to invest my hard earned due to central bank policies making it impossible to make any return anywhere without taking crazy risks. / rant off /” [Emphasis ours.]

The financial markets feel increasingly unhinged. All-time low bond yields co-exist with all-time high stock markets. Oil has collapsed along with much of the commodities complex. Emerging market currencies have been hit for six. China threatens the West with another strong deflationary impulse. Speaking of matters Chinese, Doug Noland writes:

“With global “hot money” now on the move in major fashion, it’s time to start paying close attention to happenings in China. It’s also time for U.S. equities bulls to wake up from their dream world. There are trillions of problematic debts in the world, including some in the U.S. energy patch. There are surely trillions more engaged in leveraged securities speculation. Our markets are not immune to a full-fledged global “risk off” dynamic. And this week saw fragility at the global bubble’s periphery attain some significant momentum. Global currency and commodities markets are dislocating, portending global instability in prices, financial flows, credit and economies.”

Gold is difficult to value at the best of times, in large part because it’s not a productive asset, and partly because it’s conventionally priced in a currency (the dollar) that, like all others, is destined to lose its purchasing power over time. Viewed purely through the prism of price, gold increasingly feels like something close to a ‘value’ investment, given that ‘value’ investing is essentially about picking up dollar bills for something closer to fifty cents. We’re currently reading Christopher Risso-Gill’s biography of the legendary ‘value’ investor Peter Cundill, and some of Cundill’s diary entries seem to be peculiarly relevant to this strange, dysfunctional environment in which we are all trapped. One in particular stands out, which Cundill himself wrote in upper case to make his point:

“THE MOST IMPORTANT ATTRIBUTE FOR SUCCESS IN VALUE INVESTING IS PATIENCE, PATIENCE, AND MORE PATIENCE. THE MAJORITY OF INVESTORS DO NOT POSSESS THIS CHARACTERISTIC.”

And there’s another, originally from Horace, that was also used by the godfather of ‘value’ investing, Ben Graham himself:

“Many shall be restored that now are fallen, and many shall fall that are now held in honour.”

“Finally, as expectations of rapid inflation evaporate, I want to contribute to the debate about the November 15, 2010 letter signed by 23 US academics, economists and money managers warning on the Fed’s QE strategy. Bloomberg News did what I would call a hatchet job on the signatories essentially saying how wrong they have been and seeking their current views. It certainly made for an entertaining read. Needless to say, shortly afterwards Paul Krugman waded in with his typically understated style to twist the knife in still deeper. Cliff Asness, one of the signatories of the original letter, despite observing that “responding toKrugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like manyunpleasant tasks, it's necessary”, penned a rather witty response. Do read these articles at your leisure. But having been one of the few to accurately predict the deflation quagmire into which we have now sunk, I believe I am more entitled than many to have a view on this subject. Had I been asked I would certainly have signed the letter and would still sign it now. The unfolding deflationary quagmire into which we are sinking will get worse and there will be more Fed QE. But do I think QE will solve our problems? I certainly do not. I think ultimately it will make things far, far worse.”

- SocGen’s Albert Edwards, ‘Is the next (and last) phase of the Ice Age now upon us ?’ (20 November 2014)

On Monday 15th November 2010, the following open letter to Ben Bernanke was published:

“We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.

“We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.” In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

“We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

“The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.”

Among the 23 signatories to the letter were Cliff Asness of AQR Capital, Jim Chanos of Kynikos Associates, Niall Ferguson of Harvard University, James Grant of Grant’s Interest Rate Observer, and Seth Klarman of Baupost Group.

Words matter. Their meanings matter. Since we have a high degree of respect for the so-called Austrian economic school, we will use Mises’ own definition of inflation:

“..an increase in the quantity of money.. that is not offset by a corresponding increase in the need for money.”

In other words, inflation has already occurred, inasmuch as the Federal Reserve has increased the US monetary base from roughly $800 billion, pre-Lehman Crisis, to roughly $3.9 trillion today.

What the signatories likely meant when they referred to inflation in their original open letter to Bernanke was the popular interpretation of the word – that second-order rise in the prices of goods and services that typically follows aggressive base money inflation. Note, as many of them observed when prodded by Bloomberg’s yellow journalists, that their original warning carried no specific date on which their inflation might arise. To put it in terms which Ben Bernanke himself might struggle to understand, just because something has not happened during the course of four years does not mean it will never happen. We say this advisedly, given that the former central bank governor himself made the following observation in response to a question about the US housing market in July 2005:

“INTERVIEWER: Tell me, what is the worst-case scenario? Sir, we have so many economists coming on our air and saying, "Oh, this is a bubble, and it's going to burst, and this is going to be a real issue for the economy." Some say it could even cause a recession at some point. What is the worst-case scenario, if in fact we were to see prices come down substantially across the country?

“BERNANKE: Well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though.” [Emphasis ours.]

To paraphrase Ben Bernanke, “We’ve never had a decline in house prices on a nationwide basis – therefore we never will.”

One more quote from Mises is relevant here, when he warns about the essential characteristic of inflation being its creation by the State:

“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.”

Many observers of today’s financial situation are scouring the markets for evidence of second-order inflation (specifically, CPI inflation) whilst either losing sight of, or not even being aware of, the primary inflation, per the Austrian school definition.

James Grant, responding to Bloomberg, commented:

“People say, you guys are all wrong because you predicted inflation and it hasn’t happened. I think there’s plenty of inflation - not at the checkout counter, necessarily, but on Wall Street.”

“The S&P 500 might be covering its fixed charges better, it might be earning more Ebitda, but that’s at the expense of other things, including the people who saved all their lives and are now earning nothing on their savings.”

“That to me is the principal distortion, is the distortion of the credit markets. The central bankers have in deeds, if not exactly in words - although I think there have been some words as well - have prodded people into riskier assets than they would have had to purchase in the absence of these great gusts of credit creation from the central banks. It’s the question of suitability.”

And from the vantage point of November 2014, only an academic could deny that the signatories were wholly correct to warn of the financial market distortion that ensues from aggressive money printing.

Ever since Lehman Brothers failed and the Second Great Depression began, like every other investor on the planet we have wrestled with the arguments over inflation (as commonly understood) versus deflation. Now some of the fog has lifted from the battlefield. Despite the creation of trillions of dollars (and pounds and yen) in base money, the forces of deflation – a.k.a. the financial markets – are in the ascendancy, testimony to the scale of private sector deleveraging that has occurred even as government money and debt issuance have gone into overdrive. And Albert Edwards is surely right that as the forces of deflation worsen, they will be met with ever more aggressive QE from the Fed and from representatives of other heavily indebted governments. This is not a recipe for stability. This is the precursor to absolute financial chaos.

Because the price of every tradeable financial asset is now subject to the whim and caprice of government, rational macro-economic analysis (i.e. top-down investing and asset allocation) has become impossible. Only bottom-up analysis now offers any real potential for adding value at the portfolio level. We discount the relevance of debt instruments almost entirely, but we continue to see merit in listed businesses run by principled and shareholder-friendly management, where the shares of those businesses trade at a significant discount to any fair assessment of their underlying intrinsic value. A word of caution is warranted – these sort of value opportunities are vanishingly scarce in the US markets, precisely because of the distorting market effects of which the signatories to the November 2010 letter warned; today, value investors must venture much further afield. The safe havens may be all gone, but we still believe that pockets of inherent value are out there for those with the tenacity, conviction and patience to seek them out.

“Sir, Adair Turner suggests some version of monetary financing is the only way to break Japan’s deflation and deal with the debt overhang (“Print money to fund the deficit – that is the fastest way to raise rates”, Comment, November 11). This was precisely how Korekiyo Takahashi, Japanese finance minister from 1931 to 1936, broke the deflation of the 1930s. The policy was discredited because of the hyperinflation that followed.”

- Letter to the Financial Times, 11th November 2014. Emphasis ours. Name withheld to protect the innocent.

“Don't need to read the book - here is the premise. Business dreams are nothing more than greed. And you greedy business people should pay for those who are not cut out to take risk. You did not build your business - you owe everyone for your opportunity - you may have worked harder, taken more risk and even failed and picked yourself up at great personal risk and injury (yes we often lose relationships and loved ones fall out along the way). However, none the less you are not entitled to what you make. Forget the fact that the real reason we have massive wealth today is we can now reach the global consumers - not just local - so the numbers are larger. Nonetheless the fact is that is not fair - and fair is something life now guarantees - social engineers demand that you suspend the laws of nature and reward all things equally. 2 plus 2 = 5 so does 3 plus 3 = 5; everything is now levelled by social engineers. We need to be responsible for those who choose not to take risk, want a 9 to 5 job and health benefits and vacation. The world is entitled to that - it is only right - so you must be taxed to make up for those who are too lazy to compete, simply don't try, or fail. In short the rich must mop up the gap for the also ran's. Everyone gets a ribbon. There are exceptions - if you are Google, BAIDU, Apple or someone so cool or cute or a liberal who will tell people they should pay more taxes - you aren't to be held to the same standard as everyone else.”

- ‘cg12348’ responds to the FT’s announcement that Thomas Piketty’s ‘Capital’ has won the FT / McKinsey Business Book of the Year Award, 11th November 2014.

“@cg12348, I think you succeeded in discrediting yourself comprehensively. You didn't read the book. You do not in fact know what is in it. But you just "know" what is in it. One can only hope that you do a little more work in your business ventures.”

- Martin Wolf responds to ‘cg12348’.

“Socialism in general has a record of failure so blatant that only an intellectual could ignore or evade it..”

“Since this is an era when many people are concerned about 'fairness' and 'social justice,' what is your 'fair share' of what someone else has worked for?”

- Thomas Sowell.

Forbes recently published an article suggesting that Google might be poised to enter the fund management sector. The article in question linked to an earlier FT piece by Madison Marriage (‘Google study heightens fund industry fears’, 28.9.2014) reporting that the company had, two years ago, commissioned a specialist research firm for advice about initiating an asset management offering. An unnamed US fund house reportedly told FTfm that Google entering the market was its “biggest fear”. An executive from Schroders was reported to be “concerned” and senior executives at Barclays Wealth & Investment Management were reported to perceive the arrival of the likes of Google and Facebook on their turf as a “real threat”. Campbell Fleming of Threadneedle was quoted in the FT piece as saying,

“Google would find the fund management market more difficult than it thinks. There are significant barriers to entry and it’s not something you could get into overnight.”

Bluntly, faced with backing Google or a large fund management incumbent, we’d be inclined to back Google. Perhaps most surprising, though, were the remarks by Catherine Tillotson of Scorpio Partnership, who said,

“There probably is a subsection of investors who would have confidence in Google, but I think the vast majority of investors want a relationship with an entity which can supply them with high quality information, market knowledge and a view on that market. I think it is unlikely they would turn to Google for those qualities.”

We happen to think that many investors would turn precisely to Google for those qualities – assuming they found those qualities remotely relevant to their objective in the first place. So what, precisely, do we think investors really want from their fund manager ? All things equal, it’s quite likely that investment performance consistent with an agreed mandate is likely to be high on the list; “high quality information, market knowledge and a view on that market” are, to our way of thinking, almost entirely subjective attributes and largely irrelevant compared to the fundamental premise of delivering decent investment returns.

After roughly 20 years of the Internet slowly achieving almost complete penetration of the investor market across the developed world, fund management feels destined to get ‘Internetted’ (or disintermediated) in the same way that the music and journalism industries have been. The time is ripe, in other words, for a fresh approach; the pickings for incumbents have been easy for far too long, and investors are surely open to the prospect of dealing with new entrants with a fundamentally different approach.

Another thing prospective digital entrants into the fund management marketplace have going for them is that they haven’t spent the last several years routinely cheating their clients, be it in the form of the subprime mortgage debacle, payment protection insurance mis-selling, Libor rigging, foreign exchange rigging, precious metals rigging.. Virtually no subsidiary of a full service banking organisation can say the same.

Sean Park, founder of Anthemis, suggests (quite fairly, in our view) that the demand for a fresh approach to financial services has never been stronger. In part, this is because

“..the global wealth management and asset allocation paradigm is fundamentally broken. Or rather it’s a model that is past its sell-by date and is increasingly failing its ultimate customers. The "conventional wisdom" has disconnected from its "source code" meaning that the industry has forgotten the original reasons why things were initially done in a certain way and these practices have simply taken on quasi-mystical status, above questioning.. which means that the system is unable and unwilling to adapt to fundamentally changed conditions (technological, economic, financial, cultural, demographic..)

“And so opportunities (to take a step back and do things differently) abound..

“Coming back to the.. "broken asset allocation paradigm" - the constraints (real, i.e. regulatory and imagined, i.e. convention) and processes around traditional asset management and allocation (across the spectrum of asset classes) now mean that it is almost impossible to do anything but offer mediocre products and returns if operating from within the mainstream framework. (Indeed the rise and rise of low cost ETF / passive products is testimony to this - if you can't do anything clever, at least minimise the costs as much as possible..) The real opportunities arise when you have an unconstrained approach - when the only thing driving investment decisions is, well, analysis of investment opportunities - irrespective of what they may be, how they may be structured, and how many boxes in some cover-my-ass due diligence list they may tick (or not)..”

As we have written extensively of late, one of those practices that have taken on “quasi-mystical status” is benchmarking, especially with reference to the bond market. This is an accident waiting to happen given that we coexist with the world’s biggest bond market bubble.

Another problem is that low cost tracking products are fine provided that they’re not flying off the shelf with various asset markets at their all-time highs. But they are, and they are.

We have a great deal of sympathy with the view that the fundamental nature of business became transformed with the widespread adoption of the worldwide web. There is no reason why fund management should be exempt from this trend. What was previously an almost entirely adversarial competition between a limited number of gigantic firms has now become a more collaborational competition between a much more diverse array of boutique managers who also happen to be fighting gigantic incumbents. Here is just one example. Last week we came across a tweet from @FritzValue (blog: http://fritzinvestments.wordpress.com/) that touched on the theme of ‘discipline in an investment process’. With his approval we republish it here:

1) What do you think will happen to the company and by consequence the stock price ?

2) Go through a personal investment checklist

3) Use someone else or yourself as a devil’s advocate to disprove your own investment theses

4) Have we reached “peak negativity” / has narrative played out ?

5) Are fundamentals improving ?

6) Why is it cheap ? Especially if it screens well in the eyes of other investors – i.e. exciting story, other investors, low P/E, etc.

7) Decide what will be needed for you to admit defeat / sell the position

If you lose focus, sell all the positions, take a break and start again.

Only expose yourself to serious and intelligent people on Twitter / investor letters / media and avoid the noise that other investors expose themselves to.”

Fabulous advice, that has the additional advantage of being completely free. While we spend quite a bit of time agonising over the State’s ever more desperate attempts to keep a debt-fuelled Ponzi scheme on the road, we take heart from the fact that – through social media – an alternative community exists that doesn’t just know what’s going on but is perfectly happy to share its informed opinions with that community at no cost to users whatsoever. O brave new world, that has such people in it !

- European Commission economic headlines, as highlighted by Jason Karaian of Quartz, in ‘How to talk about a European recovery that never arrives’.

“Well we know where we’re going

But we don’t know where we’ve been

And we know what we’re knowing

But we can’t say what we’ve seen

And we’re not little children

And we know what we want

And the future is certain

Give us time to work it out

We’re on a road to nowhere..”

- ‘Road to nowhere’ by Talking Heads.

In 1975, Charles Ellis, the founder of Greenwich Associates, wrote one of the most powerful and memorable metaphors in the history of finance. Simon Ramo had previously studied the strategy of one particular sport in ‘Extraordinary tennis for the ordinary tennis player’. Ellis went on to adapt Ramo’s study to describe the practical business of investing. His essay is titled ‘The loser’s game’, which in his view is what the ‘sport’ of investing had become by the time he wrote it. His thesis runs as follows. Whereas the game of tennis is won by professionals, the game of investing is ‘lost’ by professionals and amateurs alike. Whereas professional sportspeople win their matches through natural talent honed by long practice, investors tend to lose (in relative, if not necessarily absolute terms) through unforced errors. Success in investing, in other words, comes not from over-reach, in straining to make the winning shot, but simply through the avoidance of easy errors.

“Sir, Your headline “Fed’s grand experiment draws to a close” (FT.com, October 29) combines ignorance of what quantitative easing is with insouciance as to its potential effects – both of these mistakes being perennial features of FT coverage of QE. The “experiment”, as you call it, is not at an end; it is, with the purchases now ending, at its height. Only when the Fed starts selling the securities it has purchased back into the market will the US’s QE begin its withdrawal from that height; only when the last purchased security has been sold back into the market, or allowed to expire with consequent permanent expansion of the money supply, will the “grand experiment” (I would prefer that you called it “reckless gamble”) be at its end.

“Only at that point will we even start to see the results – on interest rates, on securities prices, on the economy. The outcome, as has so often been the case with such Keynesian experiments, is unlikely to be pretty.”

- Letter to the FT from Jon Moynihan, London SW3.

“The other potential cause of a sell-off in markets is through a central bank mistake. Some think the liquidity created by QE will eventually leak into higher inflation, but there is no sign of this as yet. More likely is a decline into deflation which would lead to financial distress as debts become more difficult to repay.

“If that does show signs of happening, then we may indeed get to see QE4 rolled out. Daddy might have let go of the market's hand for the moment but he's still close by.”

Strange things are happening in the bond market. Few of them are stranger than the reports that a French fund management colleague of Bill Gross (formerly of Pimco) took such exception to public excoriation from his stamp-collecting associate that he quit the business to sell croques monsieur from a food truck. According to the Wall Street Journal, Gross told Jeremie Banet in front of Pimco’s entire investment committee that, “I never understand what you’re saying. Ever.” With those credentials, M. Banet is clearly supremely qualified to become the next chairman of the Federal Reserve. As it is, he elected to return to his job managing an inflation-linked bond portfolio.